In the best of times, luxury furniture retailer RH (RH -0.37%) has been a massive success story, demonstrating incredible sales growth with strong profitability, along with guru investor Warren Buffett's stamp of approval.

In the worst of times, which retailers in general are hoping are on their way out, RH is experiencing declines and margin pressure. And Berkshire Hathaway exited its position. Ouch.

Every company goes through ups and downs. What marks a great investment story is a company that can bounce back and emerge stronger. Let's see where RH stands today.

More than a furniture company

RH sells upscale home furnishings through its museum-like showrooms and on its website. It typically demonstrates robust profitability through increasing net income and high margins.

CEO Gary Friedman has a new vision for the company that encompasses much more than selling furniture. It already operates upscale restaurants on some of its premises, but it's now angling to become a top global luxury brand, like LVMH's Louis Vuitton and Chanel. Those are high ambitions.

Its newer initiatives include a guesthouse (a fancy word for a hotel), yacht and jet rentals, and more eateries. It has acquired several new bespoke brands that fit into this new model, and it's developing a media operation to further the branding.

Temporary pressure

It was gaining momentum after a strong comeback from early pandemic declines, but that's reversed in the inflationary environment. It's still profitable, although net income has declined.

Friedman has said several times that RH is resisting the urge to mark down prices on its expensive products to generate sales. While many businesses would prefer such short-term oriented tactics to move inventory and keep sales from faltering, Friedman realizes such a move would be detrimental in the long run.

That's because Friedman is positioning RH as a luxury company with a luxury image, and mass sales would detract it from that image. It's sacrificing the benefit of short-term revenue -- along with some customers on the lower end of its market -- for the long-term value of its premium brand.

The trade-off was felt immediately. Sales decreased 22% from last year in the 2023 first quarter (ended April 29), and net income dropped from $200 million to $42 million.

Operating margin fell from 21.4% to 13.4%, which is drastic. But it's still higher than it was pre-pandemic.

RH Operating Margin (Quarterly) Chart
RH operating margin (quarterly) data by YCharts.

That gives investors a taste of how strong margins can be once sales start increasing, and it demonstrates how the pivot to ultra-luxury could be extremely beneficial in the long term. Greater luxury comes with premium prices and wider margins.

Hang in there, things are going to get better

Along with the strategy to stay premium no matter what, RH is investing in its business and branding, and is going on the offensive despite the macro environment. It has put some gallery openings on pause, but it's back in launch mode. It opened its first European gallery last month in the U.K. in what it calls a historic estate, and it plans to open stores in Brussels, Munich, Madrid, Paris, Milan, Sydney, and Dusseldorf, Germany.

It still has massive opportunities in the U.S. as it expands slowly. It only has 67 total galleries plus 54 other kinds of stores. It also has more potential within current stores to increase comparable sales and offer new services, such as the design help that is now available only in four locations.

The company is also heavily buying back shares, which is an excellent show of confidence, in addition to boosting shareholder value. It has repurchased more than $700 million in stock over the past year.

The market is still sitting on the sidelines

The future looks very bright for RH, even though the company is struggling right now. Investors are seizing the opportunity, and RH stock is up 38% in 2023.

The one thing to be cautious about is the valuation. At this price, and with its lower net income, shares trade at nearly 26 times trailing-12-month earnings. While that's below its five-year average of 29 and ten-year average of 66, it has doubled from the April-lows of just 12. However, looking at its earnings growth potential and long-term valuation averages, the stock could still be undervalued. Once the market has more clarity on earnings growth, it will bid up the stock before actual EPS growth materializes.  

RH stock may not make a full rebound until its business does, but in five years, you could already be seeing incredible gains. As long as you have the privilege of time on your side, I would call this a buy.