Is DSW Inc. Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does DSW (NYSE: DSW  ) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell DSW's story, and we'll be grading the quality of that story in several ways:

  • Growth: are profits, margins, and free cash flow all increasing?
  • Valuation: is share price growing in line with earnings per share?
  • Opportunities: is return on equity increasing while debt to equity declines?
  • Dividends: are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at DSW's key statistics:

DSW Total Return Price Chart

DSW Total Return Price data by YCharts.

Passing Criteria

3-Year* Change 

Grade

Revenue growth > 30%

22.1%

Fail

Improving profit margin

953.2%

Pass

Free cash flow growth > Net income growth

51.1% vs. 1,180.9%

Fail

Improving EPS

475.6%

Pass

Stock growth (+ 15%) < EPS growth

25.6% vs. 475.6%

Pass

Source: YCharts. *Period begins at end of Q1 (April) 2011.

DSW Return on Equity (TTM) Chart

DSW Return on Equity (TTM) data by YCharts.

Passing Criteria

3-Year* Change

Grade

Improving return on equity

703%

Pass

Declining debt to equity

No debt

Pass

Dividend growth > 25%

150%^

Pass

Free cash flow payout ratio < 50%

28.2%

Pass

Source: YCharts. *Period begins at end of Q1 (April) 2011.
^Dividend payout growth excludes impact of 2011 special dividend.

How we got here and where we're going
It sure looks like DSW put on its running shoes three years ago, because the company has come surprisingly close to a perfect score, with seven of nine passing grades today -- many of which show some very strong progress since 2011. Even if we look at DSW's free cash flow as a more accurate proxy for its bottom-line growth, it would change very little, since free cash flow has also improved at a faster rate than revenue. That makes revenue DSW's big sticking point, but there's no reason that the shoe retailer can't boost its sales enough to earn a perfect score next year. But can it? Let's dig deeper to find out.

Unfortunately for DSW investors, perfection seems a bit further away after the company reported disappointing earnings a month and a half ago. The company missed on both top and bottom lines and also reduced its full-year guidance quite a bit, and the net effect of these worrisome data points was a share-price collapse. This was the second consecutive quarterly report released this year to show a year-over-year decline on both the top and bottom lines. It hasn't been the only shoe retailer to disappoint this year -- Shoe Carnival also saw EPS plummet in March. Both DSW and Shoe Carnival released guidance at that time projecting that full-year EPS might decline on a year-over-year basis, but only on the low end of their guidance ranges.

This point should be especially worrisome to DSW investors. Although its three-year EPS growth looks quite impressive, it helps that DSW started narrowly in the red in 2011 -- over the past two years, DSW is the worst-performing shoe retailer save one, and that competitor is hurt by the fact that it makes its own footwear:

DSW Normalized Diluted EPS (TTM) Chart

DSW Normalized Diluted EPS (TTM) data by YCharts.

Crocs has fallen further on profitability, but DSW shouldn't have the same problems, since it sells hundreds of different brands (including Crocs, interestingly enough) and is responsible for manufacturing none of them. However, brand perception still matters, whether a company is selling foam-rubber flip-flops or... well, everything else. In that regard, DSW's brand might simply be lagging behind some of the brands on its shelves, since "cheap shoes" isn't necessarily a competitive advantage in a retail environment where every customer can immediately cross-reference price data online.

No matter what excuse one wants to use for DSW's recent weakness -- management seems to have settled on the old "blame it on the weather" tactic that was so popular for the first fiscal quarter of 2014 -- it's important to note that this is the only time DSW's revenue has actually declined for two straight quarters as a public company.

DSW Revenue (TTM) Chart

DSW Revenue (TTM) data by YCharts.

Shoe Carnival and Brown Shoe are in the same boat (Brown's top-line problems have been under way for a while) with ongoing declines, which indicates that this may be more than an isolated problem. Consumers may simply have decided that discount shoe warehouses aren't worth it any more. DSW might have earned a great score this year, but it won't hold on to it for long if it can't overcome this widespread malaise.

Putting the pieces together
Today, DSW has many of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

Will Apple's next smart device make a fashion statement?
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early-in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!


Read/Post Comments (1) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 3025018, ~/Articles/ArticleHandler.aspx, 9/16/2014 7:39:46 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement