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Here's Why We Think RH (NYSE:RH) Is Well Worth Watching

Simply Wall St

Some have more dollars than sense, they say, so even companies that have no revenue, no profit, and a record of falling short, can easily find investors. But as Peter Lynch said in One Up On Wall Street, 'Long shots almost never pay off.'

In contrast to all that, I prefer to spend time on companies like RH (NYSE:RH), which has not only revenues, but also profits. Even if the shares are fully valued today, most capitalists would recognize its profits as the demonstration of steady value generation. Loss-making companies are always racing against time to reach financial sustainability, but time is often a friend of the profitable company, especially if it is growing.

See our latest analysis for RH

RH's Improving Profits

In a capitalist society capital chases profits, and that means share prices tend rise with earnings per share (EPS). So like the hint of a smile on a face that I love, growing EPS generally makes me look twice. You can imagine, then, that it almost knocked my socks off when I realized that RH grew its EPS from US$1.33 to US$7.58, in one short year. When you see earnings grow that quickly, it often means good things ahead for the company.

I like to see top-line growth as an indication that growth is sustainable, and I look for a high earnings before interest and taxation (EBIT) margin to point to a competitive moat (though some companies with low margins also have moats). RH shareholders can take confidence from the fact that EBIT margins are up from 8.6% to 13%, and revenue is growing. Ticking those two boxes is a good sign of growth, in my book.

In the chart below, you can see how the company has grown earnings, and revenue, over time. For finer detail, click on the image.

NYSE:RH Income Statement, August 9th 2019

Fortunately, we've got access to analyst forecasts of RH's future profits. You can do your own forecasts without looking, or you can take a peek at what the professionals are predicting.

Are RH Insiders Aligned With All Shareholders?

Like the kids in the streets standing up for their beliefs, insider share purchases give me reason to believe in a brighter future. That's because insider buying often indicates that those closest to the company have confidence that the share price will perform well. However, insiders are sometimes wrong, and we don't know the exact thinking behind their acquisitions.

Insider selling of RH shares was insignificant compared to the one buyer, over the last twelve months. Specifically the Chairman & CEO, Gary Friedman, spent US$1m, paying about US$131.19 per share. To me, that's probably a sign of conviction.

The good news, alongside the insider buying, for RH bulls is that insiders (collectively) have a meaningful investment in the stock. Indeed, they have a glittering mountain of wealth invested in it, currently valued at US$364m. Coming in at 14% of the business, that holding gives insiders a lot of influence, and plenty of reason to generate value for shareholders. Very encouraging.

While insiders already own a significant amount of shares, and they have been buying more, the good news for ordinary shareholders does not stop there. That's because on our analysis the CEO, Gary Friedman, is paid less than the median for similar sized companies. I discovered that the median total compensation for the CEOs of companies like RH with market caps between US$2.0b and US$6.4b is about US$5.1m.

RH offered total compensation worth US$3.9m to its CEO in the year to February 2019. That comes in below the average for similar sized companies, and seems pretty reasonable to me. CEO remuneration levels are not the most important metric for investors, but when the pay is modest, that does support enhanced alignment between the CEO and the ordinary shareholders. It can also be a sign of good governance, more generally.

Is RH Worth Keeping An Eye On?

RH's earnings have taken off like any random crypto-currency did, back in 2017. Better yet, we can observe insider buying and the chief executive pay looks reasonable. It could be that RH is at an inflection point, given the EPS growth. For those chasing fast growth, then, I'd suggest to stock merits monitoring. If you think RH might suit your style as an investor, you could go straight to its annual report, or you could first check our discounted cash flow (DCF) valuation for the company.

The good news is that RH is not the only growth stock with insider buying. Here's a list of them... with insider buying in the last three months!

Please note the insider transactions discussed in this article refer to reportable transactions in the relevant jurisdiction

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.