Creativity Boosts Restoration Hardware

07/10/2014 7:00 am EST

Focus: STOCKS

Timothy Lutts

Publisher, Cabot Heritage Corporation

A few weeks ago, a 17-pound catalog with more than 3,000 pages landed on my porch; it made a big impression, not only in my house but in the media as well, explains Timothy Lutts, editor of Cabot Stock of the Month.

Restoration Hardware (RH) says the catalog—made up of 13 books—was created from earth-friendly paper and delivered in a carbon-neutral manner. The catalog became a news story—the result of creative thinking.

Other evidence of creative thinking at RH is that the company is moving away from designers and stores to curators and galleries. More importantly, those galleries are performing very well.

In fact, in his June 11 quarterly report, CEO Gary Friedman wowed analysts by reporting a robust 22% gain in revenues over the year before and raising guidance. Today, analysts are projecting 35% earnings growth for 2014 and 24% for 2015.

That’s particularly impressive because Restoration Hardware is not a young company! It was founded in 1979, had an IPO in 1998, was taken private in 2008, and came public again in 2012. And now, with Friedman at the helm, the firm is moving decidedly up-market.

At the end of the quarter, RH had 69 retail stores. And growth is coming on fast; the company has signed leases for six more stores, and is negotiating for 25 additional locations.

In sum, the growth prospects for the company are good. Plus, the firm is still misunderstood by many people. I like that because it means more potential buyers for the stock later.

Which brings us to the chart—which is very important in this case. RH came public again in October 2012, and after basing for six months at $32, had a huge run-up to $77 by the middle of last year.

That was followed by a year of banging its head on resistance at $75—frustrating to shareholders, but an intriguing set-up to onlookers. The set-up achieved its promise after the June 11 report, as the stock gapped up to $80 before climbing higher.

The greatest likely downside is either $80 (the top of the gap) or $75 (the old resistance level). If you can buy lower, your downside risk will be lower—and your upside will be higher.

Keeping it simple, as always, we’ll buy now. The breakout from the year-long basing pattern provided the setup for what has the potential to be a major advance.

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