When Warren Buffett buys something, investors pay attention. The legendary head of Berkshire Hathaway (BRK.A -0.34%) (BRK.B -0.01%) took a position in luxury furniture company RH (RH 1.37%) in 2019, and while it was a small position for his company, it's the fourth-largest stake in RH.
RH's stock price has increased 107% since then, and anyone who followed the Oracle of Omaha's movement at that time has benefited handsomely. However, RH stock is now down 30% so far in 2022. Does that make it ripe for the picking?
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Unique model, huge market
RH, which investors may remember as its former incarnation, Restoration Hardware, sells upscale furniture and home accessories. That focused niche helps it stand out from large mass retailers and capture market share in a high-revenue market.
The company operates 80 galleries, which is what it calls its showrooms. These showrooms have a strong design element in line with its luxury branding, and they're in chosen regions closest to their target market. Some of the galleries offer hospitality services as well, and the company is opening its first guest house as well as a yacht experience.
Its "ambassadors" work closely with clients to choose products, and the company recently opened a digital portal called The World of RH to pull together its various products and experiences to "elevate the brand" and present itself as a "thought leader," according to its third-quarter 2021 results.
In contrast with many mass home goods stores that benefited from stay-at-home orders with large sales increases, RH posted sales declines at the beginning of the pandemic. However, it has bounced back, and sales increased 19% year over year in the third fiscal quarter (ended Oct. 30) to more than $1 billion. Net income increased nearly 300% from $46 million in 2020 to $184 million in 2021.
These were important signs of progress since, like most retailers, RH has been dealing with supply-chain issues that are thwarting its growth. It had to delay the release of a new collection in the third quarter as well as put new gallery openings and its anticipated guest house launch on hold.
Despite these challenges, management slightly raised full-year guidance. That was due to the high performance in the third quarter as well as new store openings expected in the coming months that should be catalysts for further sales increases.
The company is led by visionary CEO Gary Friedman, who told shareholders late last year, "This is a time to be defined by our vision, not by a virus." That vision is what guides the company's strategy and makes it a compelling business.
Why does Buffett like the stock?
Warren Buffett is known for finding undervalued stocks and buying them before their prices appreciate. His favorite holding period is "forever," giving these stocks a long time to gain in price. He does, however, sell stocks for various reasons. Berkshire added a small amount to its original position in the fourth quarter of 2021 and owned 8.2% of RH's shares as of the end of 2021.
According to standard metrics, RH stock definitely appears to be undervalued at the current price. The shares trade for 17 times trailing 12-month earnings, which is low for a growing retail company.
But as much as we use the price-to-earnings ratio to evaluate a company's stock, price relative to earnings only tells a small part of the story. For a company to be considered a good value, it has to be more than cheap -- it has to be high quality, which is another important feature that Warren Buffett looks for in a stock.
RH operates a differentiated business model focused on the growing affluent market. It has demonstrated the ability to perform well under challenging circumstances. It also has growth catalysts in a strong housing market, which is being fed by people moving in the wake of the Great Resignation and trends toward working from home. With a small, carefully curated showroom collection and several stores planned out, the growth runway looks long. The company is also getting into the international market, which adds a huge addressable market.
With a 30% dip in 2022, RH definitely looks like a strong buy, with the potential for high gains compounded over time.
