Warren Buffett isn't known as a proponent of growth stocks. But his holding company Berkshire Hathaway has delivered higher returns than the S&P 500 over the past 10 years. Typically, more than half mutual funds underperform the benchmark index. In 2021, 80% of mutual funds underperformed the S&P 500, and Berkshire Hathaway slightly outperformed it. It's not surprising that Buffett has said he wants 90% of his funds invested in an index fund after he dies.
Buffett follows an investing approach that focuses on value, and part of his method is finding undervalued stocks, or stocks that trade below their intrinsic value according to valuation metrics. This assumes that prices will eventually rise to the companies' real values. After all, every method of investing has the overarching goal of seeing prices appreciate. One stock in the Berkshire Hathaway portfolio that looks ridiculously cheap right now, and has incredible growth potential, is RH (RH 1.37%).
Selling a brand, not furniture
RH has been around for decades, formerly known as Restoration Hardware. It has been led by visionary CEO Gary Friedman since 2014, who has built it into one of the foremost luxury furniture companies in the U.S. It rebranded as RH in 2012, and over the past year it's been reinventing itself again -- not in its name, but in its branding.
While it has always focused on luxury home products, it's redirecting its focus to sell itself as an experience. So while its core business will remain furniture sales, through its collection of large galleries in affluent neighborhoods, it's building out its product line to include dining and hospitality. It already owns several restaurants, mostly in its design galleries, and it recently rolled out yacht and jet rentals, all designed in the RH branding. It's also working on an RH-inspired hotel concept in New York.
Responding to inflation
After rebounding from pandemic declines with a solid forward trajectory, sales are being heavily pressured in this inflationary period. First-quarter (ended April 30) results were still fairly strong, with an 11% year-over-year increase. Net income remained robust, increasing 54% over last year. These results were at a time when retailers overall have been facing challenges as consumers watch their spending. As an upscale retailer with an affluent target market, it has greater resilience when most people are penny-pinching.
However, it won't leave this period unscathed, and in fact it has tweaked its second-quarter guidance to account for deteriorating operating conditions. It expects full-year revenue to decline 2% to 5% over last year, partially due to facing high comps growth in 2021, and partially due to slowing demand in the face of macroeconomic pressure, including softening demand in the luxury home market. But whereas stores like Target and Walmart are slashing prices to get inventory to sell, RH is sacrificing some potential short-term gains in exchange for its luxury label. Friedman said that he anticipates losing some of what he called "less valuable market share," but investing in quality and maintaining its brand positions it for greater long-term success.
Looking toward the future
Even in this environment, there's a lot going on at RH. Aside from the new ventures mentioned above, the company is rolling out a slew of new services, collections and stores to expand its business. That begins with "The World of RH", its new digital, connected system that combines products, experiences, and design under one digital roof. It's also launching an in-home design and purchase service. It recently introduced RH Contemporary, which looks to be its highest-luxury collection yet.
It's opening new design galleries in both San Francisco and Palo Alto, and it's entering international markets for the first time with a design gallery in a "historic estate" in England. It's also planning for stores in Paris and Milan.
Prior to the pandemic, RH was posting impressive growth, and it bounced back quickly. It's also profitable despite growing pressure. It's likely to experience challenges for at least the remainder of the year, but it has a healthy model, and demonstrates resilience under challenging circumstances. Long-term, this is a winning business with plenty of potential.
How to value RH?
Gary Friedman eschews Wall Street jargon. He says "I've found it surprising that many on Wall Street ask questions about our business that we rarely think about. Questions like, 'what's your total addressable market?'" His answer: "People who love what we love."
As disruptive as it is to think that way, and as much as I like that about this company, we're going to value it the Wall Street way. And that's to its advantage, because shares are super-cheap right now. RH stock is down, unsurprisingly, nearly 40% this year, and it trades at only 10 times trailing 12-month earnings. For a company still posting double-digit sales growth and healthy income, that's dirt cheap.
It's easy to see why Warren Buffett likes this stock, and at the current price, it looks like a compelling buy. Over time, it could help make you rich.
