Riding Wall Street's love affair with innovative tech businesses, Farfetch (NYSE: FTCH) saw its stock soar 158% from the start of 2020 to its all-time high in February 2021. But it's been a wildly different story since then as the shares have cratered 93% and now trade for under $6. It's safe to say that Farfetch has completely fallen out of favor.
Some investors might now be tempted to take a chance on this small-cap e-commerce stock in the hopes of achieving outsized returns from here. But I think this is the wrong strategy. Despite some positive factors, it's best to avoid Farfetch shares altogether. Let's take a closer look to see why.
Farfetch has favorable attributes
There are valid reasons investors might want to own the stock. This digital marketplace business connects 1,400 different fashion brands with customers from over 190 countries -- an impressive feat. Farfetch earns its revenue based on the activity occurring on its platform, and the more merchandise there is, the more that buyers will be attracted. Therefore, there are some network effects at play here.
Yet, the pessimism surrounding the company and its prospects has rarely been higher. Because its shares have been crushed, they trade at a price-to-sales multiple of just 1 -- down dramatically from a peak of about 15, just 2 1/2 years ago. The current valuation is also far lower than the stock's historical average.
For contrarian-minded investors, this could be a signal for massive potential upside. Besides an optically cheap valuation, Farfetch's growth over the years has been impressive. The company's gross merchandise value (GMV) of $4.1 billion last year was 356% higher than it was in 2017 as the platform found greater adoption. Revenue during this five-year period surged 496%, and the customer base has quickly expanded.
All of this wouldn't be possible if there wasn't real value in what the company offers.
Farfetch is dealing with issues
Like many e-commerce businesses, however, growth for Farfetch has slowed meaningfully.
In 2022, GMV declined 4%, and revenue was up just 3%. To the company's credit, growth in the 2023 first quarter (ended March 31) has demonstrated signs of life, with marketplace order growth (excluding China and Russia) up 18% and adjusted revenue up 13% (on a constant-currency basis) year over year. But this is a far cry from what shareholders have been accustomed to seeing.
Farfetch is facing notable headwinds. "Our reported GMV continued to be impacted by unprecedented macro forces that started in 2022, namely the closure of Russia, COVID restrictions in China, and the strong U.S. dollar," CFO Elliot Jordan mentioned on the latest earnings call.
China is starting to recover somewhat but was "still in decline" based on management's comments. It's hard to tell when the country, which is viewed as a gold mine for luxury brands, will turn back into a tailwind for the business and its growth trajectory.
Additionally, investors should consider the softening macro conditions and the possibility of a recession for the consumer. On one side, a valid argument can be made that luxury goods still sell well in struggling economies, providing a bit of downside protection. On the other side, it's not encouraging to think that there'll be less discretionary-spending capacity to go toward high-priced items. This presents a big near-term risk to keep in mind.
A more comprehensive understanding of a company isn't complete without understanding other stakeholders. In Farfetch's case, its entire existence depends on major fashion brands cooperating and finding value in being on its digital marketplace.
What would happen if Prada, Gucci, or Yves Saint Laurent, for instance, decided that selling on Farfetch dilutes their brand strength and completely ditched that distribution channel? This situation would hurt the business more than it would have any huge impact on those fashion brands. And this introduces risk to Farfetch's model.
Selling luxury goods in a digital setting is an innovative business, but I think there's a lot more to dislike than there are things to be optimistic about right now. That's why I think investors should stay away from Farfetch stock.
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Neil Patel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Farfetch. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
