The problem with amazing growth stocks is that when the market discovers them, enthusiastic investors can often converge on them quickly, sending the price through the roof. This doesn't lead to the steady stock appreciation that makes an investment worthwhile. Instead, it creates unnecessary volatility and a stock price that can undermine an otherwise healthy investment thesis.
Prices need to be tied to some intrinsic value measure to make sense. That's why investors should stay away from growth stocks with astronomical valuations. What most investors should be on the lookout for is a healthy growth stock with a reasonable valuation.
Sometimes Wall Street overlooks these stocks for various reasons, creating opportunity for savvy investors. Revolve Group (RVLV 1.57%) and On Holding (ONON -1.35%) are two such stocks right now.
1. The next wave of fashion
Fashion is an area that hasn't been broadly explored through the lens of technology, but more companies are using artificial intelligence (AI) and other new technology to bring fashion into the digital era. Revolve is one of the most compelling and successful, and if you're interested in different ways that tech intersects with different industries, Revolve is worth a strong look.
It has used AI throughout its organization in the 20 years it's been in operation, and it has built up an extremely competitive platform featuring apparel, shoes, and accessories according to the latest changing trends. Because it's all online, it can quickly and easily change its merchandise, unlike physical store chains that have to sell products on hangers.
That means that Revolve can more easily adapt to changing demands, and it can make more full-price sales without needing to discount prices to move inventory. The company has exposure to the entire world, instead of wherever it has a physical presence, and it has a growing international segment that accounted for 21% of sales in the third quarter.
Being completely online also means it doesn't have to pay for costly real estate and the extra expenses of managing store premises. That helps it absorb the effects of free shipping and returns.
The entire operation is underpinned by a reliance on technology, and it's using it in new ways to make itself even better. One new example is a size and fit feature that's leading to increased conversion rates as well as lower return rates.
Like most retailers, Revolve has been feeling the effects of inflation. It's not a discount retailer by any means, and the mass consumers it attracts by working with social media influencers and celebrities like Kim Kardashian and Morgan Stewart haven't been able to afford many of its products over the past two years or so. But these customers have remained loyal and are hanging on, buying on sale or in smaller amounts.
Now, things are starting to change. Revolve's sales increased 10% year over year to $283 million in the third quarter, and net income was up 238% to $10.8 million. Active customers have increased every quarter on a year-over-year basis since Revolve went public in 2019, and total orders placed continue to grow as well. Even average order value, which went down last year, is increasing again.
Revolve stock soared after earnings and isn't cheap right now, trading at 46 times forward one-year earnings. But that's still reasonable for a growth stock in its early innings. Wall Street sees no upside at this price, but as it recovers, the market will keep rewarding it. Revolve is still a fairly small company, but it represents the future of fashion, and investors looking to get in early still have the opportunity.
2. A fresh look in footwear
Switzerland-based On Holding is not a humble sneaker maker. It has captured consumer interest with its premium active footwear and apparel, and it's making a real challenge against incumbents like Nike and Lululemon Athletica.
It's a small operation compared to the big players, but that's not stopping it from innovating and using technology to further its efforts. It recently announced a revolutionary new product called LightSpray, where it uses robotics to literally spray a shoe onto a mold. However, it's most well-known for its CloudTec sole, which features huge holes in a foam cushion. Its fans say it's more comfortable than any other running shoe.
On is just getting off the ground, but it's growing quickly where it has launched. Sales increased 32% year over year in the third quarter, but the running-shoe maker is still not well-known in most parts of the world.
Plus, it's a premium brand targeting an upscale clientele, which means that its fans can pay full price even in the harsher macroeconomy. It has the best gross margin in the industry -- that margin expanded to 60.6% in the third quarter. It has been reliably profitable for several quarters despite the high expenses of rolling out across the world.
On stock also soared after a Q3 chock-full of excellent updates. It also isn't cheap anymore, trading at 51 times forward one-year earnings. But in the context of its growth and opportunities, I would still put that in the reasonable camp.
Wall Street doesn't see much upside at the current price, but the opportunity is enormous. I'd go with the fans in this case instead of Wall Street. If you buy today, you should be well-rewarded if you hold for the long term.
