Teenybop-clothier Deb Shops (NASDAQ:DEBS) reported disappointing comparable sales for its stores in June. Same-store sales declined 4.5% over June 2003, following May's 2.3% decline. That's not good news. But comps for earlier in the year were generally positive, and overall, the chain looks healthy to me.

I have followed Deb for a while now and think now might be a good time to explore its valuation a bit. Let's run Deb through our 7 Steps to developing a rough picture of a company's investment potential and see how the company fares, shall we?

Market cap

Deb is the ideal size for the kind of small-cap companies profiled every month in Motley Fool Hidden Gems. Not too small. Not too big. $350 million, give or take.

Enterprise value-to-free cash flow

Considering its small size, Deb is incredibly flush with cash. Subtract out its cash hoard from its market cap, and the company sports an enterprise value of just under $190 million. Divide that number by the company's $19 million in trailing free cash flow, and Deb comes in with a bargain-basement EV/FCF valuation of 10.

Historical and projected earnings growth

Suffice it to say that Deb's future outshines its past. Long term, analysts expect it to grow earnings by about 12%, but historically, the company has seen earnings decline by more than 13% per annum.


This one is tricky for a company with such poor earnings history. If you trust the analysts, Deb seems undervalued with an EV/FCF/G of 0.8. But the company's past shows it has the ability to markedly underperform.

Return on equity

The business is neither horribly nor terrifically run. Deb scores just a decent 7.4% for return on equity. For comparison, that's about half as good as competitor Limited Brands (NYSE:LTD).

Insider ownership

Insider ownership of 60%-plus gives management a strong incentive to succeed and aligns its interests with those of the shareholders. This is one reason you often see companies with strong insider ownership paying dividends: the insiders share in those dividends. Meanwhile, bigger "name" companies, such as Symantec (NASDAQ:SYMC), Cisco (NASDAQ:CSCO), or Lucent (NYSE:LU), have insider ownership in the single digits and pay zilch to shareholders.

Share dilution

All aces here. Share dilution over the past two years combined has totaled less than half a percent. Chronic diluters Intel (NASDAQ:INTC) and Oracle (NASDAQ:ORCL) could learn a few things from these guys.


Deb Shops sports a low valuation, promises acceptable long-term growth rates, manages its business with reasonable efficiency, and is run by officers with a sizeable stake in its success. If projections of future growth pan out, Deb makes for a strong value investment.

Fool contributor Rich Smith owns no shares in any of the companies mentioned in this article.