If you had bought $500 worth of RH (RH 1.32%) stock in April 2013, you would have had around $9,000 before the market sell-off last year. This leading brand of luxury decor is going after a massive long-term growth opportunity, and that's why the recent drop in the share price could be a great buying opportunity.
The stock is currently 67% off its all-time high. Even Warren Buffett's Berkshire Hathaway has a small stake in RH. Here's why investors can have confidence that the stock will bounce back.
Smart business
Over the last decade, e-commerce has made the home goods market much more competitive. Wayfair has dominated the value end of the marketplace with its expanding infrastructure and growing brand awareness. The online space is crowded and not a market where a business can hope to earn high profit margins.
RH has been smart to go full throttle toward the opposite end of the price spectrum. The company focuses exclusively on the luxury end of the market and goes even further to separate itself from competitors that are investing more in e-commerce by doubling down on the brick-and-mortar experience. RH's main sales channels consist of lavishly designed galleries and showrooms, and it also operates an e-commerce channel.
There is smart business thinking behind RH's approach. If you've checked Wayfair's finances lately, you'll know that the e-commerce home goods leader is seeing sales decline in this environment, and, even worse, is losing money.
However, selling high-end luxury furnishings that are designed exclusively by RH's network of artisan partners naturally lends itself to higher selling prices and a healthier profit margin. Indeed, RH turned nearly $0.15 of every dollar in revenue last year into a net profit, which was also superior to competitor Ethan Allen Interiors' 13.5% profit margin.
Profit Margin data by YCharts
The best part is that RH has been steadily raising its profit margin for the last 10 years. That indicates a strengthening competitive advantage.
One way RH generates higher profits is from its membership program. Last year, 97% of sales were from members. Members receive discounts, which management believes improves the customer experience, leading to higher brand value and lower operating costs.
RH only had 351,000 members at the end of 2022. However, the industry is very fragmented with no single competitor controlling the majority of the market. For that reason, management believes they have a long runway of growth, given RH's growing product assortment across an expanding range of design collections.
As CEO Gary Friedman explained on the fourth-quarter earnings call, climbing up the luxury mountain gives RH a more distinctive path to profitable growth than competitors.
It won't be an easy climb. There will always be competitors trying to chip away at the company's lucrative business model. That's why RH continues to launch new offerings to stay ahead of the competition.
Later this year, RH will launch over 70 new furniture and upholstery collections across outdoor, interiors, contemporary, modern, baby and child, and teen categories. "It represents a massive leapfrog for our brand," Friedman said, a jump that management believes could be disruptive across several markets.
A cheap stock ahead of a big opportunity
The further up the luxury mountain RH climbs, the more formidable its competitive moat becomes. That likely explains why the Oracle of Omaha's company holds the stock, which is dirt cheap right now, trading at a low price-to-earnings ratio of 12.6.
While the outlook for 2023 is uncertain -- as even a business catering to deep-pocketed clients hasn't been immune to the economic headwinds over the last year -- RH is clearly a brand on the rise. Management's focus on selling luxury furnishings to high-income households is carving a profitable niche in a market estimated at over $20 billion, based on the company's estimated addressable market.
For these reasons, RH is a good bet for market-beating returns over the next 10 years and beyond.
