Stock splits are all the rage on Wall Street. They're popular with retail investors because they appear to level the playing field with lower entry points. Although investors today can buy most any stock with fractional shares, lower price points look attractive, and they do seem to generate some modest initial gains.
Investors looking for high stock-gain opportunities, though, should always focus on the long-term outlook. RH (RH 1.37%) is one stock-split stock with massive potential.
Why this stock looks so compelling
RH, formerly known as Restoration Hardware, has big aspirations. CEO Gary Friedman, who has fostered it from a small chain of hardware stores to the luxury furniture company it is today, wants it to be a premier luxury name. He has positioned it with upscale branding and operations, and the company recently launched a series of complementary products and services that elevates it way beyond a furniture retailer. These include yachts, jets, restaurants, and guest houses.
So far, this visionary strategy is working. The company posted robust pandemic-rebound results in 2021 as its upscale clientele continued to invest in their homes despite inflation and rising costs. Management is refusing to settle into a promotional environment, which could dilute its premium branding and cost it growth in the long term.
It appears to be helping. Growth slowed to a trickle in the 2022 second quarter (ended July 30), with revenue up a fraction of a percentage over last year, at $992 million. However, that was better than expected, and gross margin expanded due to its high-margin full-priced sales. Its adjusted operating margin of 24.7% was also better than expected. RH continues to be profitable with net $122 million in net income -- although that was a drop from $227 million last year.
RH generated $23 million of free cash flow, ending the quarter with $2.1 billion of cash and $446 million in debt. While these results looks disappointing, they were fair considering the outlook and market conditions. Compare these results to Bed Bath & Beyond's 23% comparable-store sales decline and Wayfair's 15% sales decrease in the second quarter.
Management expects it to get worse, though. Sales are expected to decrease 15% to 18% in the third quarter and around 4.5% for the full year as interest rates continue to rise and the housing market gets softer. RH is also pushing off some showroom openings during this weak market to allow for stronger openings later on.
In the meantime, RH is launching new collections and services to assist its customers, such as in-home design services and a web portal with all of its products and services in one place. Its affluent customers are more resilient to inflation and have more spending power even when the economy is rough.
Warren Buffett also loves RH stock
Berkshire Hathaway first bought shares of RH stock in 2019, and it loaded up on more in the 2022 first quarter, when it went on a buying spree in the down market. RH fits the Warren Buffett model in many ways.
RH repurchased one million shares of stock in the second quarter, $255 million worth, out of a total market cap of $6 billion. Buffett loves share buybacks because they give the company more skin in the game.
The stock is now down 62% over the past year and trades at only 9 times trailing 12-month earnings, making the shares look undervalued. Yet, RH is creating a strong moat, which means it's differentiated enough to keep its core clientele and grow sales accordingly. And it's focused on and successful at generating profits.
RH announced a 3-for-1 stock split in March, when shares were trading north of $350, to take place in the spring. It still has not taken effect, and as the price plummets, management may be rethinking about the need or the timing. The next few quarters look to be challenging for RH. But stock split or not, it has serious future potential for more gains.
