I recently ran a chart of two of my family’s farms, Farfetch (FTCH -5.07%) and SmileDirectClub (SDC 0.88%). Both stocks were bullied by Mr. Market. Farfetch shares have fallen 84% since January 1, 2021 and SmileDirectClub shares have crashed 90% over the same period.
So, as always, there are only three things you can do: buy, sell, or hold. In this particular case, in August my family sold our SmileDirectClub shares and we doubled our Farfetch position. So why did we do this?
I was very bullish on SmileDirectClub in 2019
SmileDirectClub is an Internet company that provides a simple and direct consumer experience in healthcare. Instead of spending big bucks going to an orthodontist, you can fix your smile by subscribing to the company’s clear plastic retainers. These are similar to retainers that Alignment Technology developed many years ago and are no longer patented.
When my family bought stocks, the numbers were great. Smile had $586 million in revenue in the last 12 months and the revenue growth rate was 113% compared to a year ago. Moreover, the market opportunity was exorbitant.
Unfortunately, the growth story has stalled. Smile is trying to disrupt the orthodontic industry, largely cutting them out, as the middleman. Not surprisingly, the industry has fought back, trying to allege that these deposits are a health risk.
When investing in disruptive start-ups, you need to pay attention to the idea of “crossing the chasm”. At the beginning of a product’s life cycle, customers who try something new are risk takers. What you want to see happen is that more conventional people (the vast majority) start embracing the product as well.
It’s 2022 and it looks like Smile is struggling to move into the mass adoption phase. Revenue over the past 12 months was $541 million. This is where Smile was three years ago. So having zero growth in three years is more than disappointing.
Moreover, there is a downside to this business model. Once a person’s smile is fixed, you’ve lost that customer. There is no recurring activity. A smile can compensate for this with a strong word of mouth. Presumably, many people whose smiles have been repaired will have children, and their smiles will also need to be repaired.
One of my favorite business models involves repeat customers. It’s a weaker business when you constantly have to spend money to attract new customers. For now, that’s what Smile has to do. And the profits remain elusive.
Farfetch has a stronger business
Farfetch is an e-commerce platform for the high fashion industry. Whenever I see models on a catwalk, I always think, “I never see clothes like this in real life” and “Who buys this stuff?” But in reality, the high fashion industry is a huge market that will bring in around $97 billion in revenue in 2022.
Internet trading remains one of my favorite investment ideas. My first investment in Amazon is the basis of my entire investment philosophy. This stock has had a prodigious run from $4 billion to over $1 trillion. If you want me to jump and get excited, just whisper the words “Amazon tried to compete with them and gave up” in my ear. That’s why I invested in Shopifyand that’s why I made early investments in Farfetch.
Unlike Smile, the Farfetch stock was a spectacular winner for me for a few years. Like many internet names, the stock was slammed in 2021, but the company is in great shape. Farfetch has its own website and web traffic, but most of its business is in providing software as a service (SaaS) to the high fashion industry.
I love this kind of subscription business where customers lock themselves in and you get a lot of recurring revenue. High-end fashion houses like Prada and Kirin want to protect their high-end brands and therefore limit distribution to general retailers like Amazon. Farfetch recently cemented its dominance in online fashion by agreeing to acquire Yoox Net-a-Porter, an Italian online fashion retailer, from Richemont. The stock market rejoiced (which is good news because Farfetch is using its shares to pay for the acquisition).
Farfetch’s revenue growth slowed in 2021, increasing just 6% in the last quarter. I blame macro events for this slowdown. China is a major customer for the high fashion industry and of course China is currently in a mess with its autocratic government shutting down much of its economy. Sooner or later, China will open up again.
Farfetch reached its first year of profitability in 2022, so the growth story is on track and the future remains bright. Mr. Market has beaten some of the most powerful internet stocks this year, and Farfetch has not been immune to this pessimism. The company’s price-to-sales multiple has fallen 80% in the last year, from 10 to 2. When the market regains its optimism, this SaaS stock will soar much higher.
Why I Traded
These were two stocks that suffered steep declines over the past year and a half. In the case of Farfetch, my confidence remains as high as ever. In fact, I see the addition of stocks at this low point as kind of a no-brainer. With SmileDirectClub, on the other hand, my doubts started to increase. I’m still bullish on the company, actually, and I’m maintaining my positive stock selection in CAPS. I just decided to move the stock from a real money position to a watchlist position.
It’s entirely possible that SmileDirectClub is zooming 1000% higher now that I’ve sold the stock. (It’s happened before!) But I made this trade because Farfetch also has huge upside potential at these prices, and I think it’s a much safer choice on the downside.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a board member of The Motley Fool. Taylor Carmichael has positions at Amazon, Farfetch Limited and Shopify. The Motley Fool holds positions and recommends Align Technology, Amazon, Farfetch Limited and Shopify. The Motley Fool recommends the following options: $1140 January 2023 Long Calls on Shopify and $1160 January 2023 Short Calls on Shopify. The Motley Fool has a disclosure policy.