The big share price gains that Revolve Group (RVLV 1.07%) delivered to its shareholders earlier in the pandemic have been completely wiped out by this year's market sell-off. Many are worried about high inflation and lower consumer spending amid a weakening economy. But even with those headwinds, Revolve posted strong sales growth through the second quarter.
Much of the stock's pullback in 2022 can be traced to its previously high valuation. Now, its valuation is more in line with the broader market's average, but its share price has continued to slide in recent months as investors underestimate Revolve's long-term growth potential.
Revolve stock went from overbought to oversold
Revolve ended 2021 firing on all cylinders. In the fourth quarter, sales and net income increased 70% and 55%, respectively, on a year-over-year basis. That performance explains why investors bid the shares up to a peak price-to-earnings (P/E) ratio of more than 72 late that year. For comparison, the S&P 500's P/E ratio was just 25 around that time.
Data by YCharts.
But year to date, the stock has fallen over 60%. That decline can be blamed in part on management's cautionary statements about business trends in its last earnings report. Management noted mounting pressures on the consumer at the start of the third quarter with sales growth in July decelerating to approximately 10% year over year. Management warned that economic headwinds would pressure sales through the end of the year.
Perhaps more concerning was a 48% drop in net profit in the second quarter. This is not consistent with its recent operating history. One of the attractive qualities of the business is its use of data to manage its style assortment. Revolve can acquire on-trend styles quickly to boost demand. Between 2018 and 2021, Revolve's earnings per share more than tripled, growing much faster than the top line.
Data by YCharts.
However, three factors are pressuring Revolve's bottom line in 2022:
- A higher return rate for full-price items.
- Increased fuel costs for order shipments.
- Higher marketing expenses leading up to its recent Revolve Festival event -- the company's first one in three years.
The relationship between the stock price and the company's falling profit margins offers a clear picture of what's dragging the stock down. Over the last year, these cost pressures have brought Revolve's trailing 12-month net margin down from double-digit levels to 8%.
Data by YCharts.
Great investment opportunities can come when you identify a beaten-down stock where the underlying business is wrestling with temporary problems. Revolve is not suffering from execution issues, nor anything competition or company-related. It is dealing with a tough economic environment. Investors who have some patience should do well if they buy and hold this apparel stock for the long term.
Revolve stock is a good investment
Revolve now trades at 19 times earnings, a discount to the broad market. But the stock should be trading at a higher valuation for a few reasons.
First, Revolve is a financially strong business. It has over $200 million in cash on the books and no long-term debt. It can survive a slow economy and will still be able to invest in initiatives that will position it to emerge from this downturn stronger.
Second, the company's above-average growth through 2021 can be attributed to the following advantages:
- A greater selection than specialty retailers across luxury apparel, beauty products, and accessories aimed at millennials and Gen Z shoppers.
- Effective use of marketing through social media and celebrity influencers.
- Data-driven inventory management that allows it to keep up a constant flow of fresh new styles throughout the year.
A final reason to buy shares is that the client base of 2.2 million active customers Revolve currently serves represents only a small sliver of its target market. It has a lot of room to grow. For these reasons, Revolve appears undervalued and is poised to deliver market-beating returns over the long term.
