What happened

Abercrombie & Fitch (ANF 4.51%) shareholders trounced the market on Wednesday as shares jumped 16% by 3 p.m. ET compared to a 0.9% boost in the S&P 500. The move erased just a portion of the losses that the stock suffered earlier in the week, though, in response to the apparel specialist's latest earnings report.

The rally came as investors tried to judge Abercrombie's growth potential at a time when consumer spending patterns appear to be changing quickly.

A young person shopping for apparel.

Image source: Getty Images.

So what

Abercrombie's first-quarter report initially sparked a roughly 30% slump in the stock earlier this week. Sales trends appeared solid, with revenue beating management's forecast and rising 4% to $813 million. But there was bad news in the report, too, including collapsing gross profitability and rising inventory levels.

Management reduced its sales and profit margin outlook for the rest of 2022, citing inflation, supply chain challenges, and soaring transportation costs .

Yet some investors believe the sell-off was overdone. Several Wall Street firms lowered their short-term price targets while keeping them well above Abercrombie's current share price.

Now what

Like many stocks on the market today, Abercrombie is trading at a discounted valuation. You can own shares for less than 0.4 times annual sales, or about half the valuation on that basis from just a few months ago.

It's hard to justify such a stock price slump considering that the retailer is on track for another annual sales record and is projecting just a short-term earnings impact from rising costs. Yet investors are aiming to avoid negative sales and profit surprises, which might occur over the next few quarters if Abercrombie is stuck with too much inventory during a consumer spending slowdown.

It's also possible that management's profitability downgrade was too optimistic. On balance, these factors sent the stock lower so far this week, even including the rally on Wednesday.