Barron's Makes Another Premature Call: Round 2 - Restoration Hardware

| About: Restoration Hardware (RH)

Restoration Hardware (NYSE:RH) was Barron's latest weekend victim. To me, Barron's bearish take is reminiscent of its Facebook (NASDAQ:FB) call, which was also an article I questioned. The similarities and situations surrounding the two calls include both stocks being post-IPO and both articles implying that stock performance indicates value and future trends. Here is why Barron's is wrong, again!

A Look Back At Barron's Premature Call

Back in September, just four months after Facebook's IPO, Barron's published a story saying "Facebook Is Worth $15." The core arguments for Barron's included Facebook's P/E ratio, its price/sales ratio, mobile monetization concerns, bad acquisitions, and that Facebook was becoming "less cool."

I immediately responded with an unbiased look at the article, not owning shares of Facebook but believing that much of the call was created due to a falling stock price. I argued that it wasn't fair to compare Facebook's P/E and price/sales ratios to Google and Apple, and that any trading metrics should be compared to the likes of LinkedIn or Yelp, showing Facebook as cheap.

In addition, I believed it was too early to judge mobile monetization and acquisitions - turns out I was right. Moreover, that Facebook's one billion users made it difficult for another social media site to replicate the strong user base - I was right.

My final conclusion: Barron's $15 price target was premature - once again, I was right!

An Equally Premature Call

Barron's latest bearish take on Restoration Hardware comes less than one year after its IPO. In the article, Barron's essentially questions the company's plan to expand into Contemporary Art and Kitchen. Moreover, Barron's mentioned the stock's 180% post-IPO return, thus citing valuation concerns. Lastly, a string of insider sales was the finishing touch on the firm's bearish take.

First, let's address Barron's concern of "expansion" into Restoration Hardware Contemporary Art and Kitchen. Just in case you don't know, Restoration Hardware issues a home improvement catalogue where it has product offerings for bedrooms, kitchens, patios, etc.

Now, when is the last time you've heard of a bearish outlook on a company's plan to expand a catalogue? Chances are you've never heard the word "expansion" to describe such plans, nor have you heard it identified as a risk. However, Restoration Hardware's catalogue is where growth occurs, as the company is yet to increase its number of total stores. Thus, Restoration Hardware grows the old fashioned way, with comparable store sales.

Currently, Restoration Hardware is expecting full-year sales growth of 25% and comparable sales growth over 25%. In addition, the company is exploring 20 additional markets for new stores. Hence, we have a company with traffic that is exploding, that is not "expanding," but with just 71 total stores has room truly to expand. Therefore, I don't see how Barron's expansion risk outlook makes any sense.

Next, let's address the post-IPO 180% gain argument. First off, this argument alone is something I'd expect from a first-year retail investor, not a reputable company such as Barron's. Because after all, Barron's should know that price performance does not indicate value. Instead, value is determined based on a company's valuation relative to fundamentals and growth.

In a previous article entitled, "Which Stock Is Best in the Home Improvement Space?" I compared Restoration Hardware and Lumber Liquidators side-by-side. I urge you to read this piece, as I prove that Restoration Hardware has the same market value as Lumber Liquidators, but has greater revenue and comp growth, is cheaper relative to sales, and has significantly greater expansion opportunities. Therefore, it doesn't make sense for Restoration Hardware to be targeted as "overvalued" in this particular space, not when it is apparently cheaper and growing faster than a competitor.

Finally, the issue of insider selling. Restoration Hardware was hit hard by the housing bubble, and private equity and venture capitalists came together to buy the company. In November 2007, Sears took a 13.7% stake in the company; Tower Three Partners also took a large stake. However, it was Catterton Partners who bought the company in 2008 for $179 million. With the company valued at $2.8 billion when Catterton sold shares last month, it appears that Catterton made a great investment.

Personally, I have always stood on the side of the trade that viewed insider selling as highly problematic. Because after all, would you sell a boat load of shares if you knew the next six months would exceed Wall Street's expectations? However, to me, this logic only applies when the CEO or those directly tied to the day-to-day workings of the business sell shares that have been accumulated. In the case of Catterton, they are no different from me, you, or any other investor who makes one hell of a trade. At some point you have to take profits. The goal of an investment is to return more than your initial stake, and that's exactly what Catterton accomplished. Therefore, I view their activity as normal, and smart.

Final Thoughts

I understand that Restoration Hardware has fallen 13% in the last month, and that company outlooks change with the trend of a stock, but I simply cannot comprehend how Restoration Hardware is expensive. Sure, in order to have a market you need a buyer and a seller, and there are plenty of macro related concerns that you could attribute to a bearish Restoration Hardware outlook. However, the reasons given by Barron's make little sense, defy logic, and remind me very much of its case against Facebook. In my opinion, the case it built against Restoration is ignoring the other side of the trade, the one where revenue is growing at more than 25% year-over-year and that true expansion is yet to occur. In a retail space where comparable growth is the most important metric, Restoration Hardware leads the pack, and looks to be a solid investment.

Disclosure: I am long FB, RH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.