RH (RH 0.78%) and Wayfair (W -8.55%) are two key players in the home furnishing industry and both are down over 40% from their 52-week highs. Both stocks are dealing with a mix of supply chain concerns; fears that home spending, which surged during the height of the pandemic, is cooling down; and the general sell-off of growth stocks over the past few months. But both stocks are actively taking steps to combat these headwinds and pursue their own strategies. Which is the better buy right now?
This ratio tells the story
RH trades at a fairly reasonable valuation of 18 times earnings, whereas Wayfair trades at a huge premium of over 180 times earnings. RH looks far more palatable given this wide gulf in valuations, but let's play devil's advocate and assume Wayfair trades at a premium valuation because it is a newer, high-growth e-commerce company.
The price/earnings to growth ratio, or PEG ratio, was designed to level the playing field and account for this exact type of dichotomy since valuing stocks solely based on traditional valuation methods can make high-growth companies seem overvalued and could cause investors to miss out by choosing a cheap company with declining earnings instead of a high-growth company that could provide great returns. Popularized by legendary investor Peter Lynch in the 1980s, PEG ratio divides the price-to-earnings multiple by annual earnings-per-share growth. In theory, a company with a PEG ratio of under 1 is generally considered undervalued. RH trades at an attractive PEG ratio of 0.8, whereas Wayfair trades at a steep PEG ratio of 14, indicating that it is overvalued even when taking its growth rate into account.
Clearly, whether using a traditional price-to-earnings multiple, or using a PEG ratio to give more credit for growth, RH is the better value.
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Who has the lead in omnichannel?
Wayfair is starting to make the transition from pure e-commerce player to an omnichannel brand, announcing that it will open three brick-and-mortar locations in Massachusetts this year. I think that this is a great move for Wayfair, as having a physical presence to showcase big-ticket items like couches and tables will help drive sales. But RH already has a big head start on Wayfair in terms of establishing a physical footprint, with over 100 locations (including outlets) across the United States and Canada.
RH also has the unique ability to sell potential customers on its vision by showcasing its style and products at its own luxury hotels, like its flagship RH Hotel in New York City. In sum, I think establishing a physical footprint is a good move for Wayfair, but RH already has a substantial head start in this department, and distinctive aspects like its hotel brand give it the advantage. Furthermore, Wayfair could face some execution risk here, as it hasn't operated physical branches before.
Luxury is the place to be
The luxury space is a good place to be, since companies in this realm have the ability to consistently generate high margins with their pricing power. Luxury customers are less price sensitive, and their buying power is less affected by economic downturns. RH is the most prominent publicly traded pure play in luxury furniture, generating 49% gross margins. For comparison, Wayfair has a more wide-reaching approach, focusing on a wide variety of price points ranging from mass market to luxury. The resulting 28% gross margins are impressive but not as good as RH's. Furthermore, I feel that the focus on luxury gives RH more of an established and durable identity. Unparalleled attributes like a private jet and two yachts that customers can rent are also great advertisements for the RH brand.
And the winner is...
Based on its more attractive valuation on a variety of metrics, a head start in omnichannel because of its expansive physical footprint, and the intangible advantage of having an identity as a global luxury leader, RH looks like a better investment than Wayfair and, thus, a good addition to an investor's portfolio.
