Even as the market begins to look more upbeat, with the S&P 500 up 3% this year and many beaten-down stocks climbing higher, there are some top growth stocks that remain way down. Finding excellent stocks at excellent prices could spell a huge opportunity.
Warren Buffett, arguably the king of value investing, has invested in luxury furniture retailer RH (RH -3.07%), and this beaten-down stock may be wildly undervalued. It might even have the potential to at least 10x. Let's take a look at how that could happen, and why you should consider buying RH stock.
How could RH stock 10x?
RH sells high-end home furnishings to an upscale clientele. It was gaining momentum after initial pandemic-induced declines, but sales are decreasing again in the wake of inflation, as is net income. RH stock is down 34% over the past year.
Right now, RH stock has a market capitalization of $5.5 billion. To 10x, that would increase to $55 billion. RH stock sports a dirt-cheap valuation of 9.4 times trailing 12-month earnings. But it hasn't always been this cheap. Its three-year average is 30.
An average includes high and low swings, so while the the 3-year average is 30 and the 5-year average is 40, these numbers include some very large anomalies that skew the average. I would make the case for using 20 as a possible average over the next few years, but let's check a few scenarios.
RH has posted $569 million in trailing 12-month earnings. To get to a market cap of $55 billion, with a price-to-earnings ratio of 20, that would require trailing 12-month earnings of $2.75 billion -- or about 480% higher than it is today. Using the 3-year average P/E of 30, this would mean $1.8 billion in trailing 12-month earnings. That's 300% more than today. With a price-to-earnings ratio of 40, earning would need to total $1.38 billion, or just 240% higher than today.
Can RH do that? Today's trailing 12-month net income is down from its high of $689 million in fiscal 2021. In the 2022 third fiscal quarter (ended Oct. 29), net income was down by over half, year over year, to $99 million. However, even including these decreases, trailing net income has stiill increased more than 2,000% over the past five years. Its stock has gained only 214% over the same time period, still far outperforming the market.
Why should investors be convinced?
Of course, these numbers only make sense when viewed within the context of RH's market opportunities.
Management has recently pivoted from branding itself as a top furniture destination to elevating its premium image as a luxury lifestyle brand. It has rolled out various "experiences" such as an RH-branded guesthouse, yacht rentals, and fine dining establishments. Even within its core product collections, it has acquired several new premium labels.
Also within its normal operations, it only operates 67 showrooms and 120 total stores, giving it ample growth potential. It has several new showrooms in the process of opening, and it is branching out into international markets as well.
What bodes well for this strategy is that when faced with the decision of whether to mark down products, which could drive sales volume in the short term, management has opted to forego significant promotions to keep its premium branding. It sees that as a long-term-focused choice that will benefit the company later, when it can sell more full-priced items, widening its margins, and leading to stronger sales growth and profitability.
RH has the potential to 10x. It's not so likely to happen while there's still economic pressure, but as soon as that changes, RH's prospects should, too. And the cheap price isn't likely to last either, making now a good time to buy.