Fool.com: Second-Chance Investing [Special] May 5, 2004

This is part of The Motley Fool's annual Stocks for Mom special.

RedEnvelope (: REDE)
Trading at $9.16 as of 5/4/04
52-week high: $16.98
52-week low: $7.85

As we count the blessings of our mothers -- and believe me, they're many -- forgiveness must be right near the top. Or maybe that's just me. Seriously, we all make mistakes and, just as surely, strive to vindicate those willing to look beyond our stumbles.

"Unconditional love is for children," you say, "not stocks," and you're right. Successful investors save the love for mom. So let's be clear: There's no finer way to lose a ton of money than to fall in love with a stock, especially a bad one.

What to do, then, about online catalog retailer and Motley Fool Hidden Gemspick RedEnvelope(Nasdaq: REDE)? A middle child in an overachieving brood, this Tom Gardner recommendation is clearly a hard case, but which is it: good kid who goofed or a truly bad seed?

Alyce Lomax broke it down for us. "The Envelope" confessed in January that it would miss its prior forecasts, citing distribution glitches and a lack of product on hand to meet holiday demand. And miss it did. But wait, demand is good, right? Right, but bad customer service is bad, especially around the holidays -- especially when you pride yourself on "customer experience."

Worse, just as RedEnvelope was turning customers away, rivals like Brookstone(Nasdaq: BKST) and Sharper Image(Nasdaq: SHRP) were snapping them up. Worse yet, Internet sales enjoyed a banner season overall, and eBay(Nasdaq: EBAY) and Amazon(Nasdaq: AMZN) -- the holy grails of online retail -- suffered no such glitches and, frankly, haven't in eons.

If glitch it even was.

A school of smart investors makes a living preying on so-called execution glitches. Good companies grow, and even the best -- especially the best -- hit stretches where they cannot accommodate surging demand. One might even extend this notion to snafus with product rollouts and, worst case, even recalls.

The catch -- and it's a doozy -- is that a glitch can be fixed and a stumble must really be in execution, not systemic. It absolutely must not cast doubt on management or the viability of the business model. If a stumble passes these tests, the argument goes, the market reaction is swift and too severe, presenting opportunity for patient -- and I'd add, gutsy -- investors.

Think of Time Warner's(: TWX) AOL in midstream, struggling to meet a flood of new Web surfers. Or a Microsoft(Nasdaq: MSFT), more than once scrambling to roll out a (bugged) version of Windows. Johnson & Johnson's(NYSE: JNJ) mid-'80s Tylenol scare and management's swift and decisive reaction might be the enduring example.

And indeed, in April, RedEnvelope forecast fourth-quarter revenues of $16.9 million to $17.3 million, a bit higher than the analyst consensus and at the high end of its own prior guidance. The news was particularly upbeat given that Valentine's Day went off without a hitch, offering hope that things are, in fact, coming together. Understandably, eyes are on earnings due out May 11, but if you ask me, Mother's Day is do or die.

Personally, I'm less concerned with precisely where the numbers come in than with what has been done to correct the distribution glitches and to improve customer service. As we like to do with our Hidden Gems recommendations, we spoke with CEO Alison May and she assured us that customer service is No. 1. We'll see.

But keep in mind, in real time, execution glitches are not death knells only in the eye of the beholder. It took a certain type of investor to stick with, much less actually buy, AOL, Johnson & Johnson, and Microsoft during their darkest hours. Just as buying RedEvelope now necessarily implies a faith that last year's setback was a one-off event.

My feeling is that it was, but here's what I'm going to do: I'm about to eat some Gems cooking and order something for my own mother -- last-minute, in fact -- and see if RedEnvelope can pull it off.

If not, as my sister used to say, "I'm telling Tom!"

Paul Elliott is editor of Tom Gardner's Motley Fool Hidden Gems (take it for a free spin) and doesn't own shares of any stock mentioned in this story.

A Stock for Mom represents the opinion of one Fool and should in no way be taken as the opinion of either The Motley Fool, Inc. or the company in question, or as representative of anyone or anything other than that specific Fool's thoughts. The Fool has a disclosure policy.