Today's Buy Opportunity: Blue Nile

Welcome to the final installment of "11 O'Clock Stock!" Over the past 50 days we've been searching out great investments and investing our own money along the way. If you want to keep tracking the performance of the portfolio, check out our CAPS profile, which tracks the portfolio against the market, or our portfolio site with links to each recommendation. Also, remember to keep coming back to Fool.com every day for all your investing news!

When called upon to make my first pick in "11 O'Clock Stock," I went with FedEx even though the company looks richly priced. However, the stocks I buy rarely look cheap, and I stood by my three principles of investing, all of which I believed FedEx embodied:

  1. I buy excellence, and it's never cheap.
  2. I go where the trends favor me.
  3. I hold longer than just about anyone I know, which includes 100% of Wall Street.

For today's pick, I'm standing by those three principles once again. Internet retailer Blue Nile (Nasdaq: NILE  ) might not look cheap, but it continues to prove its worth, and I don't see the company being displaced anytime soon.

Fast facts on Blue Nile

Market Cap

$639 million

Revenue (TTM)

$320 million

Earnings (TTM)

$13 million

Cash/Debt

$47.1 million / $0.8 million

Competitors

Tiffany & Co. (NYSE: TIF  ) , Amazon.com (Nasdaq: AMZN  )

Source: Capital IQ, a division of Standard & Poor's. TTM = trailing 12 months.

Diamonds, an investor's best friend?
Blue Nile is the Internet's leading retailer of diamonds and fine jewelry. While an online purchase might not seem like the ideal way to find expensive jewelry, Blue Nile has been very successful at cornering the online jewelry selling niche.

Blue Nile succeeds a couple of ways: First, it's very good at educating and pointing shoppers to exactly the right diamond. It has a large inventory and several areas to help shoppers learn more about purchasing diamonds and other fine jewelry. Second, Blue Nile's cost structure allows the company to undercut bricks-and-mortar rivals by up to 40% and enjoy the sales tax benefits of selling online.

Back to those three principles
At the top I'd listed three of my core investing principles, the first of which is that I buy excellent companies, and they're never cheap. That's definitely the case with Blue Nile. The company trades at nearly 50 times trailing earnings.

However, as my second principle states, I also go where the trends favor me. Despite some bumps along the way, for investors, the Internet remains the great development of our time. The best part for investors is that Internet companies aren't easily displaced. I don't think anyone will out Amazon Amazon.com, and it won't be easy for anyone to displace Blue Nile either. While Tiffany is a much larger competitor, they're targeting a different segment of jewelry. Also, their cost structure is much different than a pure-play Internet retailer like Blue Nile.

In the case of Amazon, while they offer a jewelry section of their own, buying jewelry has always been a specialized enough field that big retailers can't easily dominate it. Blue Nile's exclusive focus on jewelry and educational areas gives it a key advantage in a purchasing decision that buyers put plenty of research and time into.

Finally, when it comes to my final principle, that I hold longer than just about anyone I know, I've recommended Blue Nile twice in my Rule Breakers service. Each time, as it does now, Blue Nile looked expensive when using your traditional value measures. In spite of this, my recommendation from 2006 has outperformed the market by 36%, and my original 2004 recommendation is outperforming by 44%. I've held Blue Nile for the long haul, and I expect it to keep outperforming into the future.

Bottom line
Blue Nile is extremely effective at selling jewelry online, but its status as a specialty retailer limits its growth scope. We're not looking at a company looking to explode into a $10 billion giant. However, the jewelry market is extremely fragmented, and there's ample room to continue taking share. Not only that, but Blue Nile still derives nearly 90% of its sales from within the United States, so there are plenty of untapped markets for Blue Nile to expand into.

If you're looking for an underappreciated franchise with a solid grip on its market niche, look no further than Blue Nile.

Interested in reading more about Blue Nile? Add it to My Watchlist, which will find all of our Foolish analysis on this stock.

Previous recommendations (click here for full list of recommendations and performance):

"11 O'Clock Stock" is sponsored by Motley Fool Stock Advisor. The Motley Fool will wait at least 24 hours after this publication before purchasing shares of Blue Nile. To see an FAQ on "11 O'Clock Stock," click here.

David Gardner owns shares of both Blue Nile and Amazon.com. Blue Nile is a Motley Fool Rule Breakers pick. Amazon.com and FedEx are Motley Fool Stock Advisor recommendations. The Fool owns shares of FedEx. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (28)

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.

  • Report this Comment On October 04, 2010, at 1:05 PM, plange01 wrote:

    with the US now over two years into a depression dont expect to see much in the way of holiday diamond sales or for that matter any holiday sales!

  • Report this Comment On October 04, 2010, at 2:42 PM, MazonCreekRich wrote:

    well, honestly, i find that i always disagree with david gardner - it always seems to me that he is paying too much for stocks and holding then well past the time they should be sold. but there is one other way in which we are different -- he is a massively successful investor, and I am not.

    so I am going to just go ahead and buy this stock and hold it forever, and we shall see what happens.

    Rich

  • Report this Comment On October 04, 2010, at 8:43 PM, tzapa wrote:

    This is not exactly a buy opportunity, it's a hope and a wish that someday this company will actually be worth it's PE ratio. There are much better and less risky options. Do your sown homework instead of listening to "experts" who recommend companies with declining revenues and a PE of 50. Really, I think we can do a lot better. How about a solid company that's beaten down and likely to come back strong? Some good buys (right now - tomorrow am) are MDT, EXC, or Michelin. I'm not saying that you shouldn't take a chance with a small amount of your portfolio, but this isn't a buy opportunity - it's speculative at best and I wouldn't want to be buying it in this current volatile market.

  • Report this Comment On October 05, 2010, at 10:32 PM, Glycomix wrote:

    Dave Gardiner is the only person that I'd listen to when considering a stock whose numbers look like this for the reasons already mentioned and more: PE, declining chart price, $45 resistance ceiling.

    Excepting Activision, David's picks have been consistently, amazingly successful. Here are a few of his winners that didn't seem exceptionally strong based on their numbers: DISCK (the Discovery Channel) and SAM (Samuel Adams Beer); David Gardiner correctly predicted that Disney and Apple would breakout and soar. I didn't move on Disney, or Samuel Adams Beer, but I bought Apple when David said and three days later it had a 10% jump in stock price. After I bought the DISCK, the stock value soared. Each time that I went along with David, I reaped benefits.

    For the record, David I'd have been much more comfortable with NILE if you'd told us that your wife had bought diamonds from Blue Nile over the internet and enjoyed the experience. Excepting jewelers, I've seen very few men who understood the psychological factors involved in buying jewelry . Like makeup, it's traditionally a woman's area of expertise.

    The Positive Side:

    On the positive side, NILE has almost no debt; For the past seven years the numbers for NILE has been steady; it has had from and average 10% return on Assets with a range from 9.6-11.6% and 11% net income with a 10% to 14% range.

    It's down 30% this year, so It could easily go up. It reached a high of around $90/share in 2007, of around $60 in 2009 and is at its lowest valuation since that. It's rarely been below $40 in the past seven years except for the record low of $20 during the Fall of 2008 Fannie and Freddie's welfare-loan depression.

    Conclusion:

    I'm buying it. The chart shows that NILE has hit its bottom, and the news that David Gardiner is recommended will increase the share price at least $10. David is the Cary Grant of stock analysts. Everyone wants to see whatever he's doing.

    I regret that I'm going to have to sell silver, gold mining, and oil stocks to buy enough NILE to make money. No worries, David's recommendation is a 95% sure thing.

  • Report this Comment On October 22, 2010, at 2:12 PM, tzapa wrote:

    How much money you would have made if you had purchased any of the stocks that I listed - how much you would have lost if you purchased Nile!

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