Motley Fool Hidden Gems Investing - Can Stitch Fix Get Fixed?

Episode Date: September 25, 2024

The fashion company has a lot to offer its customers, but StitchFix is struggling to keep those customers around. (00:21) David Meier and Mary Long discuss: The disconnect between the stock market and consumer confidence. Stitch Fix’s fall. Why great consumer products don’t always make for great investments. Then, at (14:03), Ricky Mulvey and Fool contributor Lou Whiteman take a look at Palantir, a tech company with a lot of promise and a lot of expectations. Tickers mentioned: SFIX, RTR, PLTR, BAH Host: Mary Long Guests: David Meier, Lou Whiteman, Ricky Mulvey Engineers: Rick Engdahl, Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

You gotta try breakfast at A&W. You gotta try breakfast at A&W. And what better way than with a delicious Pret Organic Coffee, starting at just $1 all day, every day, now until December 31st. You gotta try breakfast at A&W. At participating A&W locations in Ontario. Your personal stylist is calling. Motley Fool Money starts now.

I'm Mary Long, joined today by David Meyer. David, thanks for joining me. Thank you for having me. Always a pleasure. Always a pleasure to have you. Today, let's say we're celebrating. The S&P 500 hit a new record high yesterday. This is not the first time that that happened since the Fed's rate cut.

Are you celebrating? Of course. Love new highs. We love new highs. Also yesterday, though, we got new data on consumer confidence, and that was a little less rosy. There was a disconnect, it seems, between that consumer confidence data and these all-time highs that we're seeing in the stock market because September's consumer confidence index slid by its largest level in three years. So when you get conflicting data points like this, how do you square them and kind of make them make sense and tell a story? So, a very good question. And I think the

first thing we need to do is to look and see what the consumer confidence data is actually telling us. So, yes, it declined month-over-month, and it declined from about 105, according to the index, to about 98, let's say. So, the situation is far from dire. During the great financial crisis, the index dropped to around 25 at the nadir. That's bad. Consumers are very unhappy at that point. Even if the consumer confidence changed, dropped at a pretty precipitous level, it's still pretty high given that the index is based on comparing it to 1995's confident level being 100. The other thing to remember is that the economy is not the stock market and vice versa. Many other things impact stock prices such that

we can't always make a direct connection between the two. But that said, consumer confidence is considered a leading indicator. What I would take away from this is, we got to continue to pay attention to this data because consumption is a huge part of our economy. Allow me to dive into the details a little bit and get a bit nerdy here. You mentioned, okay, it was 105, slid to 98. I think someone could be forgiven for thinking, 98, that's on a scale of 100. But if it slid from 105, that's certainly not the case. So how do we put those numbers in context? So the one thing that we have to remember is August's number was actually revised up. So once they get the entire data and they look at data set and they look at it again,

you never know. September's number could be increased as well. So, this is a little bit flowing, but it could just be about August itself, the transition between August and September itself. Maybe things get better, maybe consumers feel more confident after the rate cut data starts to get digested. That doesn't happen immediately, right? It takes time. There's a lag between when an event happens and when it actually flows through the economy. So I still think now with just one data point essentially being drawn, we need to wait and see what next month's data says before we try to draw a line through it. So I would say, pay less attention to the individual macro data pieces and let's focus on the companies. Okay. So I'm going to

follow exactly what you said and move from the macro to a specific company. Unfortunately though, while the S&P 500 hit all-time highs, this stock is not moving in the same direction. The stock I'm talking about is Stitch Fix. It reported earnings yesterday and is down, last time I checked this morning, about 35% on those numbers. You were on the morning show today, which is a show on our members-only live stream, Motley Fool Live, and you were a bit melancholy, you said, about this news. So you were a believer in the Stitch Fix idea. What was that idea? What about it did you find so compelling? So, yeah, it does make me sad to see this company down so sharply today following

its earnings. But let's start from the beginning. So, the idea around Stitchfish, at least as I saw it, was that the company wanted to use technology to bring together fashion supply and fashion demand. Fashion demand was, hey, here's a quiz that you can take to let us know your fashion preferences, what styles you may like or be willing to try. And we have relationships with suppliers that we can say, hey, does this fit with what you're looking for? And then, you know, the way that would work was Stitch Fix would overlay the demand data with the supply data, data, have its suppliers offer the merchandise, and then the customer could then pick and

choose what Stitch Fix sent them and decide, yes, I'll buy this, but no, I'll return this back to you. If you think about it, if it did that well, Stitch Fix could actually get more accurate over time in sending clothing options to its customers because it would iterate on the data and get to know you even better and make sure that the trends that it's seeing in fashion match with what you were looking for. And I thought there would be enough interested parties out there to help build this into a nice solid niche business. So, that was the way I was looking at it. And I found it compelling because, again, it was taking technology and bringing it to

another industry fashion in order to try to move the whole industry forward. Yeah, so then let's fast forward to today and the news that came out yesterday. The good news, if we want to start there in this report, is that the results were actually in line with management's expectations. The bad news is that management had set that expectation bar pretty low. Revenue for the year fell 16%. They lost customers. That's the continuation of a trend. Why isn't this idea sticking?

Is this a company problem? Is this an environmental problem, just tied to the macro environment that we were talking about earlier? Where did the company go wrong? That's such a good question. And I will say, I haven't followed the company as closely as I did a number of years ago. But especially when I was deeper into what it was doing, I think it has to do with customer satisfaction. If you think about it, based on what Stitchfish wants to do, If customers were happy with their experiences, with Stitch Fix bringing them to the intersection of fashion supply and demand, like I talked about, they'd be staying with the platform,

they'd be repurchasing more, and unfortunately, that's not happening. So, something is breaking down in the experience, and it could be a big miss in terms of fashion or it could be even little things like, hey, it's taking too long for me to get a refund or it's difficult for me to get stuff from you or send stuff back from you. But unfortunately, just the experience isn't there and Stitch Fix hasn't found a way to fix that yet, pardon the pun, and get the company and the stock moving in the right direction. Everybody likes a turnaround story. And there is some other goodish news when it comes to Stitch Fix.

They ended the quarter without much debt. They've got about $250 million in cash, positive free cash flow. Is there a path back to broader health for this company? Let's say that you, David Meyer, fashion extraordinaire, are brought in by Stitch Fix to right the ship. What are you doing? Wow. So you're going to have me play armchair CEO? I am.

Did Anand put you up to this? No, I've not been put up to this, I promise. A favorite of his scoreboard techniques. Obviously, I'm kidding, I love that part of our show as well. So, a phenomenal question. And I think my answer, unfortunately, starts with figuring out how to get this company private. So, what do I mean by that? It has to get out of the eye of the public markets. Right now it's struggling, and it doesn't need the extra scrutiny that public markets put on a company as it tries to engineer a turnaround. The other challenge associated with that is, I just don't see any private equity firm wanting

to pay any sort of premium right now. But the point that you made above where it has a strong balance sheet, there still is some cash flow, the company has been trying to get its cost structure more in line with its revenue intake right now. So, there may be something there, but let's say I'm the CEO and I am able to engineer a take private, so I don't have to be in the public eye, so to speak. I think it's about getting the company back to its simplest form, which is probably a lot smaller. Fewer people, fewer things that it does, and it's got to really figure out how to attract and delight customers from there. Again, my read on it is that the experience is lacking. It's got to figure out a way to

delight those consumers such that it gets word-of-mouth advertising, things like that, that, brand recognition, more better brand recognition, be sure to check those net promoter scores. But look, this is not an easy turnaround and I think it does have to be done as a private company and then if they can get it turned around, spin it back out to the public markets. Stitch Fix makes clear that it's not a subscription business. You can utilize a subscription recurring option, but you don't have to in order to play with the company. There are other companies, Rent the Runway being one of them, that kind of play in this space where you can do a one-time order. You can do a subscription recurring setup as well. But basically, they're both playing in

the same idea of fashion at your doorstep, right? Yes. As a consumer, I'll be honest, I find this appealing. Rent the Runway, I like their products. Every time I go to a wedding, I'm renting a dress from Rent the Runway. I have a wedding to go to this weekend. My mom and my sister are coming into town for it. We have six Rent the Runway packages that are going to be at my doorstep tomorrow. But that company has also not fared very well since its IPO. When it IPO'd in 2021, it hit nearly $400. And today, its stock trades at under $10. Like Stitch Fix, they've been losing customers. I think like from a Lynchian person, we talk a lot about Peter Lynch and like his style of investing, about like going out into

the world and investing in products that like you as a consumer are familiar with that you find compelling that you understand and that you use. But sometimes great consumer products are actually not great investments. How can you kind of tell the difference between something that you might Love is a consumer, but that is not a good investment vehicle. So, did you take your super question pills this morning, Mary? Every day, David. Daily regimen. This is actually very important. You should definitely always be paying attention to potential ideas that you see with products

that you make or, excuse me, that you buy or that people in your family buy, that's a great way to discover ideas. So, how do you tell the difference? Well, one thing is, you actually have to go beyond what you're seeing directly. Are others seeing it? Like, are people in your families buying the product as well? Do you see friends? Do you see things on social media, what's the vibe? You got to take your observations and what you want to have happen, let's say, with a grain of salt and see if the data is actually confirming, yes, this is actually a big idea that I'm seeing and not just, let's say, a flash in the pan. Then the other thing you have to do is you have to understand how the business

it makes money, how will it continue to make more money in the future, and then watch and see if it actually performs. I never invested in Stitch Fix, despite my affinity for the idea and my affinity for the founder. That's because in its time of heyday growth, it never really seem to be gaining any of the economies of scale that I expected it would. At that time, it made its valuation multiples not really compelling. Basically, I think the message is, one, take your own observations with a grain of salt and see if there are other ones confirming your idea. Two, get to know the business. Three, make sure it performs by producing the cash flows that you're expecting.

There's no substitute for doing the hard work, I guess is what I'd like to say. David Meyer, thanks so much for doing the hard work and for joining us today. Always a pleasure to have you on Motley Fool Money. Thank you, Mary. Up next, Ricky Mulvey and Lou Whiteman take a look at Palantir,

an enterprise technology, data analytics, AI defense company with a lot of promise and a lot of expectations. Palantir is one of the hottest artificial intelligence stocks on the market, and investors believe we're either looking at the next NVIDIA or Shopify in 2021, which is a real company, but one where expectations have been completely blown up to what the business can do. It's led by a charismatic CEO and co-founder, Alex Karp. Lou, at the heart of this, though, we're talking about an enterprise technology company that's broken into three pieces, which is Foundry, Gotham, and Apollo.

There's a lot of talk about Palantir, but let's talk about what the business actually does. What do these pieces do? Yeah, so kind of to sum it up and to oversimplify, but Palantir is a data analytics company. It can take massive amounts of data from various sources and make sense of it, kind of respond to queries, see things, and make connections much faster than the human eye can. It's our founder, Peter Thiel, of course, famously the founder of PayPal. The idea for this came out of PayPal's work to develop fraud detection systems, which,

again, massive amounts of incoming data and quickly making sense of it. To break down the three parts, basically, Gotham is the series of tools for intelligence and military customers, government customers. Foundry is the version sold to big corporate clients. And Apollo is sort of their next generation cloud-based scalable platform, kind of offering the same services, but in a different, more user-friendly way. And Apollo is kind of where their focus is today. The base of what kind of built the company were those defense applications. So let's dig into Gotham.

What are some military use cases for Palantir? So the most famous example, and this has been confirmed. I don't know if it's officially confirmed, but Palantir is credited with helping to find Osama bin Laden. That's actually a great way to think about how this is used. The U.S. intelligent community is constantly taking in massive amounts of data from around the world. The challenge is making sense of it in real time. Palantir's tech was able to recognize patterns that pointed to the location. There's a lot of more mundane but essential applications as well. not every example of how this is used was kind of on that level, but organizing COVID shot

inventories, streamlining government processes. The common thread is the technology has the ability to, again, look at very, very complex moving data sets or multifaceted operations and quickly make sense of it. That is their core strength. A lot of the bull case, and what I'm about to say is what I've heard, and I don't know if it is true. So I want to make that disclaimer. It is what NVIDIA is to chip designs, what it is for the hardware of artificial intelligence platforms. Palantir is for the software platforms. And what the product is able to do if you're a commercial application is you have all of your softwares running, Palantir is able to interact with those, pull data, and then build business-specific large language models and allow companies to make faster decisions based on the sort of business brain that it has introduced into all of its software. What's so special about the artificial intelligence platform that Palantir is selling? Why is there so much excitement about it?

So, I mean, in some ways this is semantics, but, you know, long before we were talking about AI, Palantir was a leader in machine learning, which to my simple brain is the same thing kind of before we marketed it as such. It's the concept of, again, training computers, as you say, to make sense of and organize patterns in what looks like chaos. So, I think, as you say, arguably, Palantir, their advantage is they were AI before AI was cool. That they actually have years and years of experience developing this, and they are just further along than a lot of the companies that call themselves AI. All that said, I do think they've done a really good job promoting themselves and selling into the AI revolution, which kind of has fueled the hype.

but look, this isn't vaporware. This isn't a parlor trick or getting a computer to write limericks. Palantir deserves credit as an example of what advanced technology AI can actually accomplish in real world applications. And kind of that is why people are so excited about it. Are there competitors that offer a similar product? Kind of. I think it's really hard to do a like for like comparison, but on the commercial side, the corporate side, companies like Snowflake, Databricks can do a lot of the same things. increasingly Microsoft, Alphabet, Amazon, other big cloud providers have similar tools embedded or are trying. On the defense side, there may be a dozen defense IT companies that can stitch

together similar products. And in a way, that's the bigger competitor for Palantir here. These aren't off the shelf the way, say, Gotham is. But depending on the application, sometimes a customized, in-house, built-from-scratch platform is better than the one-size-fits-all and make it adapt. And so these companies at times are able to better compete against Palantir just because they don't have that off-the-shelf offering. And you do need to dig down deep, if that makes sense. Yeah. You have to stitch together different solutions. That sounds hard. I don't want to do that. This company is also profitable on an operating and a net income basis. It also trades at 35 times sales, three, five.

It was in the teens about a year ago, which is still, that's high expectations. But why have expectations changed so much for this company, which has been around since the early 2000s in just the past year? So look, a lot of it is AI hype. And if we're honest, as I said before, I think Palantir, to their credit, is better at most than amplifying the hype. And that's in part thanks to kind of the way they operate. In part, they have a very enthusiastic shareholder base.

Just this week, I was looking, there was a ton of headlines concerning a $100 million military contract awarded to Palantir. Looking quickly on the day it was awarded, I see at least five larger Pentagon contracts awarded that day for various things, but with very little coverage. So part of this is just the feedback loop associated with this company. But at the same time, I don't want to be too cynical here, because the tech is solid, the interest is real. Similar to NVIDIA, there's a combination of a very, very solid business with great potential and investor enthusiasm that is fueling things and contributing to the valuation.

I'm not going to say there's nothing there with NVIDIA. I'm not going to say there's nothing there with Palantir either. But the valuation is, we'll see. Yeah. And it's one of those things where a few years from now, if it turns out to be true, if it turns out that this is the best AI software platform, there's no competitors that are able to catch up at all, then it's a $50 billion company and that could be cheap as a lot of big AI companies are in the trillions of dollars. Let's get to the bear case though. We know about the expectations. What happens if this software isn't rolled out to customers as quickly as its investor base expects. Yeah. I mean, the bear case here is, and as you say, it's what if it doesn't go

to plan. We started seeing questions asked about the payoff of AI in just this last quarter, a lot of companies. Palantir's software, inside the Pentagon at least, had a reputation of being very complicated, very expensive, but it does the job. Are corporate clients who are suddenly getting pushback on their spending, going to think twice about signing a big deal for very, very expensive software. I think that's a risk, even if the technology is real. It's funny, Ricky, you said, could they get to be a $50 billion company? They are already an $86 billion company by market cap, even with revenue of just $3 billion annually. So the bear case simply is the tech is real. There's a real path towards justifying that valuation. But when you're priced

to perfection, so to speak, you darn well better be perfect. And life very rarely goes to script and is perfect. I don't know why I said $50 billion. We're leaving it in. That's how quickly this company is moving. But I think it was before it's bull run. It was around 50 billion. And then you're right. It moved to $83 billion in market cap company. I know this is something that you're approaching with that. I'm also approaching with some amount of skepticism because I'm not confident that the bull case or the bear case is true. But I know you've looked at a lot of sort of companies that had those large defense contracts. You've looked at a lot of, not on the AI side necessarily, but aerospace companies. Is there some history here? Are there other stories that

have led you to be more cautious and skeptical about what's going on with Palance here right now? So there is a long history going all the way back to post-World War II of basically failure when defense companies tried to sell to the commercial world or when commercial tries to sell to defense. One really underappreciated thing about the defense sector is dealing with that government customer, with all of the arcane procurement processes, the budget cycles, all of that, dealing with that is a core competency. The big defense companies succeed in part because they understand that customer and they can deal with it. And unfortunately, that skill set doesn't help you as much if you're pitching to, say, General Motors. Now, Palantir could be different.

They have a much different founding story than most companies in defense. But if nothing else, it should be a word of caution that these transitions from selling to the government to selling to corporate world, they always seem to fall apart or run into a lot more trouble than they thought. Just a few years ago, Raytheon was going to sell its defense IT cybersecurity products to corporate customers. And if you think about it, who wouldn't want Pentagon-grade firewalls, right? I mean, that sounds like a compelling sales case, but the whole effort flopped and Raytheon

is now part of a bigger company in part because it flopped. Palantir can pull this off, but if they do, it's important to note they will be the exception, not the rule. And I think that is reason for caution as they go towards corporate. The company is led by what I would describe as a wild mind. And if you want a lot of market beating tech company, you kind of need a wild mind. A lot of them have led that before. And in this case, it's Alex Karp.

for those who are unfamiliar with Alex Karp, what should these potential investors who are just starting to look at the company know about him? I like that wild mind. And again, Elon Musk can be described the same way. And they both love to rail on short sellers. I think Karp is called short sellers compared to cocaine addicts. But that doesn't necessarily mean that they aren't also brilliant and capable of building amazing companies. With Karp, he isn't Musk, but he is one of a kind. And for anyone investing and considering this is defense and espionage and all of these kind of dark areas, you should know this CEO and this company is unapologetic about who they are. In 2020, when the company registered to go public in the S1, CARP famously trashed

Silicon Valley and the reluctance of the Googles and the Amazons of the world to do business in the Pentagon, saying we have chosen sides and we stand by our partners when it's convenient and when it's not. That's not for everyone. It's either commendable, not commendable. That's for an individual to decide, but it's something you should be aware about. This is a guy who believes what he believes and he's not afraid to say it. And take that for the good and the bad. And as we wrap up, this is a company with a very engaged following, much more engaged than any other big tech companies, I would say. It's an active subreddit. There's a lot of conversation about it on X. If you're not already in the group and you're seeing this level of

fanaticism for a company like this, what should investors consider before jumping into a company with a cult of personality? So I struggle with this because, you know, we talked about this before we started recording. I love the technology here. I see the potential. And so I kind of want to believe. But then you see the valuation, you see kind of some of the hype around it. And And I can't figure out what to make of it. Now, whether it's Palantir or other companies that kind of have this cult around it, I try to find comparisons to sort of filter the hype. It's tough here because there isn't a like for like.

There aren't two Palantirs out there. There's not a GM and a Ford. But, you know, you take a Booz Allen Hamilton, a really, really good defense IT company with massive ties to the intelligence community. It's trading at two times sales. And as you said, Palantir is trading at 35. definitely palantir can do things to booze alan camp and so maybe i can argue they deserve a much higher valuation but is it that big of a gap i i don't know you know no matter how you come down

on that answer i think you should at least ask the question and use comparisons to other companies to try to filter through some of the excitement that is built into a price on a company like this And I'd also say it's okay to not be all in or all out on an idea and have both excitement and skepticism. Lou Whiteman, thanks for joining me. Appreciate you breaking it down. Always a pleasure. As always, people on the program may have interest in the stocks we talk about, and

The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Mary Long. Thanks for listening. We'll see you tomorrow. Thank you for watching.