Since COVID, I’ve spent more time investing and developing a thesis about which companies may benefit from the recent global upheaval.

Below, I share some recent thoughts and specifically why I believe Stitch Fix has been an underpriced gem.

DISCLAIMER: This post is not intended to provide financial advice and is for informational purposes only. Buying and trading stocks is risky and you should consult your own financial advisors before engaging in any transaction.

Personal Background and Recent Investing Strategy

I’m a serial entrepreneur and most recently the co-founder of Material World, a venture backed fashion tech company that has so far raised ~$20M.

We style individuals with pre-owned designer items by learning their preferences and then send them a monthly box with 5 items they can buy or send back. Our primary service makes it possible for customers to enjoy designer fashion at fast fashion prices while shopping sustainably.

This Box model is pretty much identical to that of Stitch Fix.

In general, my strength for the past 14 years has been identifying trends early, using growth models to evaluate potential outcomes, and taking swift action. While one of my majors was economics, till recently I invested little in public markets.

Early this year that changed as I analyzed the COVID situation and concluded that the US economy was going to be devastated by the virus.

On February 21st, the S&P’s 3rd highest day in history, I bought the deepest out-of-the-money Puts available with a strike date of March 20th against companies I was sure would crater in case of lockdowns, which I viewed as inevitable. My primary targets were NCLH (Norwegian Cruises), SBUX (Starbucks), LYV (Livenation), PLNT (Planet Fitness), MAR (Marriott), M (Macy’s). These Puts delivered a 50x return by the time I got fully out 3.5 weeks later.

Since then I have made a few additional investments but have mainly been waiting on the sidelines as Congress and the Fed flooded the market with money and stimulus.

My current primary thesis is that given 0% interest rates, unlimited QE and willingness to print money for stimuli it’s very risky to bet against the general market or against companies that will be kept on life support for an indefinite time.

However, even if demand doesn’t recover fast and we enter a major recession, I see opportunity in companies that were unfairly penalized by the market downturn, are fundamentally healthy, and ride megatrends that are accelerated by COVID.

6 Reasons I think Stitch Fix is a great company that was unfairly penalized

One: Stitch Fix has had great financials for years and retains a strong financial posture

  • At Material World, we used Stitch Fix quarterly and annual reports to interview CFO candidates. I spent a lot of time thinking about their model and poring over their data.
  • Stitch Fix has been cash-flow positive since 2014, EVEN WHEN IT WAS A SCALING VENTURE-BACKED STARTUP, and has a strong balance sheet. This is something no other fashion e-commerce company I know of has achieved.
  • Today Stitch Fix has ~$300M+ in cash and investments, no long-term debt, and positive free cash flow.
  • When we reviewed their reports one criticism that kept coming up was that they were TOO conservative. Today, their prior caution insulates them from and empowers them to take advantage of the upheaval.
  • Physical retail’s death will only accelerate with COVID
  • Given the extant desire to try things on without paying up front, Stitch Fix’s model serves a unique need which some customers may not find in ordering one-off items and returning them if they don’t like them
  • Personalization and curation is the future. Customers no longer want to sift through endless options but want an amazing, personal touch
  • Combining its own lines with 1,000+ brands, Stitch Fix enjoys inventory flexibility while juicing margins
  • Brands and retailers have an inventory glut and nowhere to sell it. Also, they don’t want to aggressively discount publicly
  • Stitch Fix distributes items discreetly and at scale
  • As a result it will likely get much better terms and/or consignment deals, reducing inventory risk. This will lead to better margins after years of margin contraction
  • Stitch Fix has economies of scale and a powerhouse data-science team of ~125 which creates hard-to-replicate optimizations
  • Based on reports and our analysis, Stitch Fix Boxes deliver a Keep Rate of around 2 out of 5 items sent. Also, accessories like socks and underwear juice sales per box. As somebody running a similar service, I’m confident this is an exceptionally strong number that represents effective, data-driven matching.
  • Combined with a data firehose and feedback loop second to none, Stitch Fix’s algorithms promise to continuously match customers better, driving sales and ultimately, margins
  • Stitch Fix’s data creates a defensible network effect in that every incremental user improves the matching algorithms, driving better matching and thus retaining and attracting more customers.
  • My Personal Experience: I signed up to try Stitch Fix and as much as I wanted to dislike it, I couldn’t help being a happy, paying customer. Whenever I received a box and planned to cancel, there would always be at least one or two killer items that dissuaded me
  • The Stitch Fix quarterly and annual reports are solid, useful reading. The management seems to be made up of good, professional, business people who are looking to build a long term asset
  • Stitch Fix insiders are buying big
  • Bill Gurley recently spent $6.3 million to buy 400,000 shares; Steven Spurlock spent $16.6 million on 1.05 million shares.
  • Shipping disruptions that impact supply will soon be resolved
  • Declines in consumer spending will have limited impact given Stitch Fix’s affordable price points and algorithm-driven pricing intelligence

Some Reasons I Could be Wrong

  • The COVID related reduction in demand may be so severe that Stitch Fix will not be able to grow
  • Rivals such as Amazon will successfully move into the fashion category, reducing potential market share, compressing margins, and increasing user acquisition costs
  • Stitch Fix may be too conservative and thus not iterate boldly enough to capture the market opportunities that arise and focus too singularly on its existing Box business
  • The Box business is reaching saturation and further growth will be substantially less profitable
  • Due to swings in customer preferences, the Box business may lose its luster over the coming 2–3 years and churn could significantly increase

Conclusion: Stitch Fix has a great shot to dominate key parts of the $430B fashion market as it goes online in the coming 5 years

With ~1.5 million boxes delivered per month, Stitch Fix has access to a HUGE userbase that powers its tech-driven moats and leverage

As a result of COVID, the addressable market for Stitch Fix’s core offering will grow, especially given its ability to accrue multiple subscribers per family

Furthermore, as fashion commerce moves online, Stitch Fix’s scale, logistics and tech empowers it to iterate and expand into new categories and business lines including:

  • The personal shopper experience at scale: a direct to user service which can also break into the higher priced, designer category.
  • The (online) store of the future: a curated and personalized experience driven by inventory, data, and machine learning.
  • The secondary market for fashion: Secondary sales are the fastest growing category in fashion. With 1.5M boxes going to and fro customers monthly, Stitch Fix is the only company that can initiate a circular model of selling items and buying trade ins at scale. Combined with personalization, this can be a big win.