2 Reasons to Buy Stitch Fix Before Earnings, 1 Reason Not To

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Predicting a company's earnings report is always a risky business. Not only do earnings reports vary significantly from quarter to quarter compared to analyst estimates, but the market reaction to quarterly reports is also difficult to predict -- even strong results can lead to sell-offs if investors find reasons to be skeptical of the company's future.

Still, plenty of investors are likely wondering if Stitch Fix (NASDAQ: SFIX) is a good buy before its fourth-quarter earnings report, due out on Oct. 1 after market close. The company is unique on the stock market as an online personalized styling service: It ships clothes to customers based on fit and style preferences rather than allowing customers to choose the items directly. Though it has competitors in that sector, including Nordstrom's (NYSE: JWN) Trunk Club, Stitch Fix is far and away the leader in the segment; sales are projected to be $1.23 billion this fiscal year.

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The stock has also surged recently, following its third-quarter earnings and an improving view of the company's potential. Shares have nearly tripled since its initial public offering last November, and more than doubled since the last earnings report in June.

Let's take a look at what could swing the stock one way or another once earnings come out on Monday.

Retail sales are booming

Consumer confidence is at a record high, nearly every major indicator shows the economy is booming, and retailers are reaping the rewards. Both Walmart and Target have posted their best quarterly comparable-sales growth in over a decade, and department stores like Macy's, Kohl's, and Nordstrom have also seen strong sales growth as nationwide retail sales have roared higher. Clothing sales jumped 6.6% from May to July 2018 (the months of Stitch Fix's fourth quarter), and another 6.3% in August, an unusually strong pace and much faster than the historical average.

That surge should bode well for Stitch Fix's fourth-quarter report, especially as the company caters to higher-income consumers who have benefited the most from the economic expansion and stock-market gains, and who have the most discretionary income to spend. Given the sales surge that Nordstrom experienced in its most recent quarter, with comparable sales up 4%, it's likely Stitch Fix experienced a similar bump, as a study from data-research company Second Measure found a strong correlation between Stitch Fix and Nordstrom sales.

Stitch Fix Kids

The market cheered following Stitch Fix's third-quarter earnings, in part because of the announcement of Stitch Fix Kids. The company's new styling service for children officially launched July 10, just in time for back-to-school season. Stitch Fix Kids is the latest example of the company expanding its brand umbrella and opportunity; it also recently added men's and plus-sized segments. Such categories add to the company's long-term growth potential, and are logical extensions of the brand. Many of the women who make up Stitch Fix's core customer base are also busy moms; the company says that more than half of its 2.7 million customers are parents, and they are likely to appreciate shopping for their kids with the unique convenience offered by Stitch Fix.

The U.S. children's apparel and footwear market generates $69 billion in annual sales, a considerable opportunity for the company, especially considering that kids' clothing has experienced little disruption in the e-commerce era.

Earlier in September Adobe Digital Insights data showed record online sales for this year's back-to-school season of $58.1 billion, and the National Retail Federation projected that the back-to-school season would reach $83 billion in sales. Retailers have not yet reported sales for the back-to-school season. But given expectations for Stitch Fix Kids, the new platform could have added a boost to the company's sales in the fourth quarter, and given it momentum into the current quarter. Look for an update on the kids' segment in the upcoming report.

The upside may already be baked in

While strong retail sales and the new kids' platform could propel Stitch Fix stock following the earnings report, investors may have already bid the stock up sufficiently -- it's more than doubled since the June earnings report. Stitch Fix shares actually rallied as high as $52.44 before falling more than 20%, in part due to a valuation-related analyst downgrade and concern about a threat from Amazon.

Indeed, the company's underlying performance may not warrant such a sudden surge in the stock, given revenue growth of 30% in its most recent quarter, and bottom-line growth that is likely to moderate as the company invests in its new platform. Stitch Fix will have to keep reminding investors of its long-term prospects in order for the stock to move higher. As I've argued before, there are a number of reasons to believe in the stock's long-term opportunity, but shares may be ready for a breather after the recent rally.

We'll learn more on Monday. Keep your eye on customer growth, and the company's new platforms, as the best evidence for where Stitch Fix is headed.

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Jeremy Bowman owns shares of Stitch Fix. The Motley Fool owns shares of and recommends ADBE and Stitch Fix. The Motley Fool recommends JWN. The Motley Fool has a disclosure policy.