I'm a big fan of Peter Lynch's classic book about investing, One Up on Wall Street, and of the philosophy he describes. Part of that is the really simple approach of finding companies you love and that offer products and services that your friends are using, and investing in them as they take off.
If you chose to invest that way, you might have bought shares of Lululemon Athletica years ago when its yoga pants began to appear at gyms all over the country, or in Starbucks if you enjoy a morning latte and noticed its coffee shops appearing on every corner. If you'd paid attention, done some digging, and recognized that those companies had great fundamentals, you'd be sitting on some serious stock gains today.
Those companies may still be compelling as investments, but they're no longer the early-stage opportunities they once were. However, if you pay attention now, you could find the next Lululemon or Starbucks. With that in mind, let's jump into On Holding (ONON 2.66%).
The newest premium footwear craze
On is best known for its Cloud running and walking shoes, which feature innovative soles and unique designs. The company, headquartered in Switzerland, was created by athletes to provide a true comfort and performance experience. It has quickly expanded and gained a cadre of loyal fans willing to pay big bucks for its footwear and other gear.
It piqued my interest when I heard On is a publicly traded company because On footwear has completely taken over my community. Its shoes have been ubiquitous for a while now, which means that either they last for a long time or people keep buying them -- or both. They are expensive, but while they target affluent shoppers, many people are willing to pay their premium for On's comfort and quality. Its main products are footwear, but it also sells athletic apparel and accessories.
Driving growth through targeted expansion
One thing On is not is Nike. That spot's taken, and it serves On's purpose to build out a niche-driven business that targets a more specific clientele. In On's case, this is a lucrative market that pays full price, driving margin expansion and profits. On is obsessively devoted to product development and technological specifications, and the result has been that it has engaged customers and earned brand loyalty. Like I said, these shoes tend to last a while, making them worth the money even for people who don't always buy premium products.
Management has espoused a four-pillar growth strategy: increasing brand awareness; expanding its footprint through a targeted, omnichannel program; innovation; and dedication to operational excellence. It still only has a 9% brand awareness in the U.S., and as it generates more, it could capture a huge revenue-driving opportunity. It already has done so in key U.S. markets, with 7% market share in New York and 15% in Miami.
On sees a current market opportunity of $25 billion in its running-related merchandise, but it plans to expand its collection to compete for a slice of the $70 billion addressable market in premium lifestyle and sport, eventually growing to enter the full activewear market that it sees as being worth $355 billion.
A resilient customer base defies macro headwinds
On's growth rates have been outstanding considering the macroeconomic backdrop. Consider its 2-year compound annual growth rates from 2021 and 2022 in key geographic markets.
Image source: On Holding.
That trend has continued this year. In the third quarter, sales increased 47% year over year. The company is demonstrating particular strength in direct-to-consumer channels, which both demonstrates and bolsters its branding and loyalty generation. Direct-to-consumer sales increased 55% year over year in Q3.
High demand plus premium pricing leads to wider margins and increased profits. Gross margin reached a record 59.9% in the third quarter, up from 57.1% a year earlier. Net income increased 184% from last year, and On has reported three consecutive quarters of profits.
Is this shoe stock a shoo-in for your portfolio?
On only went public in September 2021, and with any new stock, there's some inherent risk. Nike's growth may be slower, but it's reliable and based on sound fundamentals. Lululemon also has years of demonstrated excellence to back it up, along with a competitive edge in its yoga-inspired collection.
By contrast, On is still building its brand, its edge, and its customer base. Many new and premium activewear companies become trendy for a while before shoppers move on to the next hot thing. On looks like it's already more than the newest flavor of the month. It has a solid fan base and is taking a growing market share in a competitive space, and its profits are increasing as it scales.
The stock is also trading a valuation similar to that of Lululemon even though it's growing faster.
ONON PE Ratio (Forward 1y) data by YCharts.
On Holding stock isn't for the most risk-averse investors, but if you have some risk tolerance, it could be a standout stock to add to your portfolio ahead of an anticipated bull market in 2024.
