Who Will Win the Teen Retailer Throwdown?

It's been said that it is a poor craftsman who blames his tools, and this holds true for investing as well as anything. Still, anyone who's built a cabinet by hand knows a nail gun can get the job done faster than a hammer.

One of the tools I like to use to help me more quickly get a bead on investments is Ycharts.com. Ycharts pulls financial data from a company's Securities and Exchange Commission filings over the years, and then displays that data so investors can see how a business has developed over time. It is also useful for comparing different companies at a glance to see how big a lead a dominant company might have or which newcomer is on a trajectory to become top dog. With that in mind, let's take a look at some of the leading teen retailers as an example, and see which one is the best investment.

Five enter the arena
Over the last year, there have been two clear winners, Zumiez (Nasdaq: ZUMZ  ) and Abercrombie & Fitch (NYSE: ANF  ) , both of whose shares are up more than 50%, while Aeropostale (NYSE: ARO  ) , Hot Topic (Nasdaq: HOTT  ) , and American Eagle Outfitters (NYSE: AEO  ) are up in the single or low teens.

Source: YCharts.com.

But if we look at the earnings yield, essentially the inverse of the P/E ratio, we can see some of this optimism is unfounded. Aeropostale's yield has been steadily increasing as it grows earnings while the stock trades sideways. Its competitors have had their yields crushed over the past couple years, as their stock gets bid up through the roof without corresponding earnings growth.

Source: YCharts.com.

The big reason for this has been a reversal of mood. When the recession hit, investors and shoppers alike flocked to Aeropostale, whose high discounts appealed to shoppers on a budget. But now that the economy appears to be recovering, some of Aeropostale's bad-weather customers are returning to pricier retailers. The result is that investors are discounting the company's future growth and putting a premium on the others.

Source: YCharts.com.

There's something important to note about this revenue chart above. Even ignoring the obvious plus of growing revenue during the recession, there's something to be said for Aeropostale's stability throughout the period. Abercrombie and Zumiez may be showing incredible growth now, but only after huge declines.

In the chart below, you see that Aeropostale didn't suffer a single quarter of negative earnings growth during the period, the only one among the group to say this. Meanwhile, Zumiez and Abercrombie show line breaks on their graphs, revealing the spots where they actually had losses (the line breaks because it's mathematically impossible to calculate growth from a negative number).

Source: YCharts.com.

Margins are another reason investors may be worried about Aeropostale. The price of cotton has nearly tripled over the past six months, and with the lowest gross margins of the group, the company is the most sensitive to these cost increases. Abercrombie, conversely, has wide enough margins to eat some of the cost before passing it on to customers, and its wealthier customer base will have less trouble dealing with price increases when they come.

Source: YCharts.com.

But this misses a quirk of Aeropostale's business model, whose administrative expenses are smaller than its competitors'. It doesn't pay models to stand shirtless outside its stores in the New York winter, for example, nor does it have a soft-core catalog to run on the side. Low prices are a big part of Aeropostale's brand identity, and, consequently, it's as if the company has shifted some of its marketing expenses to operating costs.

Source: YCharts.com.

As a result, Aeropostale ends up with the highest overall profit margins of the group, beating highflier Abercrombie by 4 percentage points, as you can see below.

Source: YCharts.com.

And one emerges
The winner of this throwdown, much like those featuring celebrity chef Bobby Flay, comes down to a matter of taste. For a momentum growth investor, skitching a ride with Zumiez or Abercrombie might be profitable for a while, but huge expectations have already been priced into these companies, and they aren't likely to hold up well when trouble comes. Even Abercrombie's large gross margins won't protect it unless it can bring down its even larger SG&A expenses.

On the other hand, a value investor is likely to prefer the flavor of Aeropostale. Trading at just 10 times earnings compared to 19 for Abercrombie, the market has very low expectations. There's no denying that growth is slowing and may finally dip negative this year as the company loses market share to higher-priced rivals and fights rising commodities costs. If that happens, a low P/E can easily become a high P/E. But right now, Aeropostale is looking about as cheap as its merchandise.

For more Foolishness:

Fool contributor Jacob Roche recommends no one look into Abercrombie's A&F Quarterly while at work. It's just not a great idea. He owns calls on Aeropostale but holds no position in any of the other companies mentioned. Zumiez is a Motley Fool Big Short short-sale pick. The Fool owns shares of Aeropostale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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