Warren Buffett is one of the most successful investors of all time, with his holding company Berkshire Hathaway returning a market-beating 20% annually since he took the helm in 1965. Home furniture company RH (RH 1.37%) joined the portfolio in late 2019, and Berkshire now owns 2.36 million shares of the company, valued at roughly $581 million. Let's discuss why RH could also have a place in your investment portfolio.
What is RH?
Founded in 1979 as Restoration Hardware, RH is an upscale home furnishing store that sells items ranging from furniture to lighting fixtures through its network of galleries and outlets throughout the United States and Canada. Like many retail companies, its business faces macroeconomic headwinds related to inflation and rising interest rates. Third-quarter earnings highlight the impacts of these challenges.
Revenue dropped by 14% to $869 million, while operating profits fell by 38% to $170.3 million. As a home goods company, RH's business depends on the strength of the housing market. But when the Federal Reserve hikes interest rates, mortgages become more expensive, then home sales slow, and RH's business model takes a hit. CEO Gary Friedman expects these negative business trends to continue for the next several quarters. But over the long term, RH's core thesis remains intact.
A widening economic moat
Coined by Warren Buffett, the term "economic moat" refers to a company's ability to maintain a competitive advantage over rivals and protect its profit margins over the long term. For RH, this depends on transcending its furniture shop roots and positioning itself as a global luxury brand, with all the potential growth and margin enhancement that entails.
To pull this off, the company is broadening its business to become more lifestyle-adjacent to the wealthy. Changing its name from Restoration Hardware to the more sleek and ambiguous "RH" was the first step in this process. Now the strategy has evolved to include opulent restaurants and guest houses in its showrooms. In December, the company expanded its portfolio with the acquisition of Dmitry & Co and Jeup Inc., designed to give RH a bigger presence in custom-made furniture and upholstery -- businesses that target a wealthy clientele.
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These efforts won't necessarily power growth in their own right. Instead, they are aimed at boosting the brand's cachet, which will help ensure its future success. And while it may take some years for the strategy to play out, RH has a good track record.
The company increased its revenue by 76% to $3.76 billion between fiscal 2016 and fiscal 2021 while boosting its gross margin from 32% to 49% over the same time frame, a sign the luxury transition is bearing the desired results. So while investors may have to deal with a few rough quarters until the housing market improves, the future looks bright.
An excellent valuation
Warren Buffett is known to like betting on value stocks, and RH fits into that category. With a forward price-to-earnings (P/E) multiple of just 13, shares are significantly cheaper than the S&P 500 average of 21. The recent declines seem to price in RH's near-term headwinds, allowing investors to bet on its long-term strategy.
