One Slick Stock

I recently found myself wondering about Urban Outfitters (Nasdaq: URBN  ) . Its quarterly earnings looked pretty excellent, but its share price looked like it might be downright expensive. It seemed like a good time to take a closer look at this hip retailer.

Urban Outfitters is best known for its self-titled stores, which are mostly aimed at young people who are in college or post-college. This is evident in its edgy fashions, which differentiate it from other retailers that court young people, like Abercrombie & Fitch (NYSE: ANF  ) or American Eagle Outfitters (Nasdaq: AEOS  ) . (At times, it has gotten itself in trouble with investors and parental types with controversial items like those that outraged Fool contributor Rich Smith last year. Of course, it seems that didn't stop the kids from coming.)

What some investors may not be aware of is that the company operates the Anthropologie and Free People stores -- which also cater to more artistic, bohemian, and romantic styles.

Anthropologie's quite a coup, considering the fact that it targets women aged 30 to 45 or so. That's an affluent and fashion-conscious demographic that Chico's (NYSE: CHS  ) , Ann Taylor (NYSE: ANN  ) , and Gap (NYSE: GPS  ) all seek to attract.

Urban Outfitters has made some savvy choices about which customers to target, and how, which accounts for the stock's recent success. A Foolish reader pointed out something that underlines the company's good vibes: Urban Outfitters doesn't even advertise, and still the customers keep coming.

However, the company's stock is currently trading at 40 times forward earnings, and 45 times trailing 12-month earnings. After its most recent earnings announcement, it barreled onward and hit a new 52-week high. With a market cap of $3.66 billion and trailing 12-month sales of $752 million, it's clear that Urban Outfitters no longer has the small-cap, under-the-radar appeal of the stocks selected for Motley Fool Hidden Gems, and it doesn't flout conventional wisdom and carve a path for itself like the stocks that are profiled in Motley Fool Rule Breakers.

However, it may be a tried-and-true retail stock that investors should think about owning, or if they do own it, consider keeping for the long term. So, there's no time like the present to examine some of the financial criteria that many Fools know and love.

A peek at the numbers
We already know that Urban Outfitters' third quarter was perfectly respectable -- some might use a term like "blow out." (For a recap, click here.) Not only did it grow sales and earnings by hefty percentages, it also delivered solid same-store sales gains despite a difficult comparison to last year. Meanwhile, its gross, operating, and net margins, which began to falter around 1999 and 2000, continue to improve, with the upward trajectory approaching those achieved during boom times. (As of its last fiscal year, gross profit margin, operating margin, and net profit margin had grown to 38.9%, 14.7%, and 8.8%, respectively. This latest quarter, they were 42%, 20%, and 12%.)

For the last couple years, Urban Outfitters' sales have been growing between 20% and 30%, a figure most retailers would envy. Net income has been growing between 43% and 83% every year since fiscal 2001. Its goals are to provide 25% higher sales and 3% to 4% same-store sales increases -- and it has been consistently meeting, exceeding, or even downright spanking those benchmarks.

It's also good to note that Urban Outfitters does generate positive free cash flow, and it's even sweeter that it has debt-free status. Over the last two full years, Urban Outfitters grew free cash flow by 88% per year. Given its debt-free status, that tells us that the company is funding expansion through cash on hand. We like that, given that taking on too much debt for expansion was one of the things that caused problems for Gap several years ago.

There are a few other things we like to check, though, like Flow Ratio. The Flowie, one of the criteria we use to decide whether a company is a Rule Maker, measures whether a company is managing its working capital efficiently, and we look for it to be below 1.25, and preferably below 1.0. Urban Outfitters just barely fails here, with a Flowie of 1.28.

The Cash King Margin, another Rule Maker criteria, is also helpful when examining financial statements. This metric measures how much free cash flow the company is able to squeeze out of sales. For the first nine months of this year, the Cash King Margin is 5%, which means for every dollar of sales, the company is squeezing out a nickel in free cash flow. For fiscal year 2004, Urban Outfitters managed a Cash King Margin of 7%.

Bear in mind that Urban Outfitters' Cash King Margin has been regularly improving over the last several years. Last year, its Cash King Margin was 3%, and the year before that, the company had negative free cash flow.

A vested interest
As a retail store that's got the inside track on the collegiate fashion mindset ("upscale homeless" is a hip moniker for style these in-between kids prefer), it's no wonder that its roots are close to a college. The very first Urban Outfitters opened up in 1970 near the University of Pennsylvania campus in Philadelphia. Its first Anthropologie store opened in 1992, also in Philly. The company launched its first Free People store in 2002, in the Garden State Plaza Mall in Paramus, NJ. The company currently has 134 stores, meaning it still has plenty of room to grow.

That's all fine and good, but what about management? One thing that Foolish stock experts often look for is insider ownership, meaning that the company's officers and directors have a vested interest in the company's performance.

A quick peek at Urban Outfitters' most recent proxy statement reveals that the company's co-founders Richard Hayne (who is also the chairman and president) and Scott Belair own 32.6% and 3% of the company's shares, respectively. That's a good reason to suspect they're interested in delivering value to shareholders.

What next?
Given some of the calculations we've done here, Urban Outfitters may not be the perfect stock, but it sure does have plenty of positive aspects to recommend it. Meanwhile, its continued expansion -- it plans to open between 28 and 30 new stores next year -- and continued popularity should help to make this a good stock for investors to hold on to for a while, given what looks like a promising growth trajectory.

However, in terms of buying into the stock at present, it does look a bit pricey. Even though one might justify its high P/E ratio given expectations that it will continue to grow its earnings by a good clip, it's arguable that there's not much margin for error. Meanwhile, many of us know that retail can be a risky area to buy into, given the fact that it's at the mercy of often-fickle fashion trends, especially with younger shoppers.

Interested investors may want to wait for a temporary dip in stock price -- especially given some tough same-store sales comparisons coming up -- to consider buying into what may very well be turning into a great retail investment story.

Gap, which is planning a retail concept that will likely compete against Urban Outfitters' Anthropologie for the whims of affluent, mature customers, is aMotley Fool Stock Advisorpick. Keep up with all the latest picks by trying it for six months, risk free.

AlyceLomax does not own shares of any of the companies mentioned.


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