Taking Timberland for a Walk

I have always thought of stock evaluation as being analogous to setting out on a strenuous hike through difficult terrain. Prior to departure, it is essential that hikers prepare themselves for the journey ahead, stick to the trail, and anticipate setbacks. Many scenic hikes in our national parks also traverse some of the most dangerous ground. Thus, one must not get sidetracked or risk being mauled by fire ants, falling boulders, or the all-too-familiar bear.

This brings me to Timberland (NYSE:TBL). The company's hearty tan hiking boots were a staple of my household growing up in the snowy Northeast U.S. They were our ultimate weapons against the drifting white powder, and we hauled them out without hesitation during the winter months.

These aren't your childhood boots
Now that I live in Southern California, where snow is as ubiquitous as a Republican in Haight-Ashbury, and since fatherhood has rendered my hiking days a distant memory, Timberlands had vanished from my psyche... until just today. I find myself in a camping store where patrons are snatching up these shoes like kids grabbing candy from a smashed pinata.

I scan the racks and discover that Timberland isn't just selling those plain tan hiking boots anymore. In fact, it is selling everything but. The shoes are all reasonably priced; most sell for under $120. The crafting and style on the footwear are outstanding. These are clearly more than my childhood Timberlands ever were.

Vision dictates action
Then the most extraordinary thing happens. I have a vision! Peter Lynch, shock of white hair and all, appears before me. He sticks his finger at me and proclaims in an unearthly voice, "Buy what you know!" He points to his feet. He wears a pair of Timberlands. Then he vanishes. (Please note: I have no idea if Peter Lynch actually wears Timberlands.)

The time is nigh. I must evaluate Timberland as a stock. The words "hidden gem" scream at me. If Timberland has been out of my mind for so long, maybe others have also overlooked it. I pull up its key statistics on the computer, see it has a return on equity of 30.97%, and... get called to give my daughter a bath. No, not now! Not with an ROE of 31% staring me in the face. Heck, I think, I don't need to see more anyway. I enter an order for several hundred shares to be executed on the open and tend to the kids. I retire to bed without going any further with my research.

Pebble in the shoe
That night, I have a terrible dream. I am hiking with my Timberlands up Yosemite Falls. I pound up the trail, just as I had in reality 15 years ago, so well prepared that when I hit the summit the sudden hailstorm barely affects me. All around me, however, are inexperienced hikers in shorts and tank tops, shivering under what little cover they could find, knees pulled tight to chests, staring longingly at my poncho and long pants.

Then everything changes. Suddenly, everyone else is wearing the proper gear and I am the dunderhead without proper protection, curled up in a fetal position under a tree. And Peter Lynch is there, in his Timberlands, wagging a finger at me, "Buy what you know -- at a reasonable price." He laughs maniacally, as do all the other hikers. I look to the sky and scream, "Nooooooooooo!"

I bolt upright in bed, in a cold sweat, and look to the clock. 6:45 a.m. My buy order has gone through. I finish my due diligence, only to discover to my dread that I have indeed committed the equivalent error of hiking four miles in-country without packing food, water, a map, or a compass -- and a storm threatens on the horizon. I committed capital without proper research.

A Hidden Gem?
Fortunately, it turns out that Timberland is a solid company. It just isn't the hidden gem I thought I'd uncovered. At a market cap of $2 billion, it is larger than I'd prefer. Its EV/FCF/G ratio is 1.15 and its PEG is 1.24, which suggests it is mildly overpriced. I can't honestly say that its product has a sustainable competitive advantage. Boots are boots, after all. Wolverine World Wide (NYSE:WWW), Nike (NYSE:NKE), and a host of other private companies like The North Face produce excellent footwear as well. Nor is Timberland out of favor and thus undervalued.

A silver lining in ROE
There is, however, plenty of good news. A company can't generate a 31% ROE without there being a few other things that shine through. It's generating some healthy cash flow, has coin in the bank and zero debt, and a strong net profit margin. To wit:

All this number crunching doesn't even mention two other concerns. As fellow Fool David Meier has pointed out, it's taking over 100 days to convert resources into usable cash flow for the company. Also, Timberland is a retail business. Now, boots may not be as subject to teen fashion fickleness as are products of Abercrombie & Fitch (NYSE:ANF), Pacific Sunwear (NASDAQ:PSUN), or Hot Topic (NASDAQ:HOTT). Still, boots are boots, boots are retail, and retail has that random "fashion factor" that makes for dicey investments.

Action dictates reaction
So now what do I do? By my estimation, I have overpaid for a good company with a product I know and understood. Do I stay in the woods without supplies, build a lean-to and wait, or do I try to hike back through the storm?

Fortunately, my trading commission costs are low because I've chosen a discount broker. I could sell and only incur a tiny loss of a few bucks, but the loss isn't the issue. It's the fact that I bought a stock based on limited research and a surge of giddiness.

The lesson
The lesson is one all investors learn repeatedly, and often forget repeatedly, during our careers. Something catches our eye, like a coin glinting to a crow, and we swoop down on it without really examining it in detail. It's hard to watch a Travelzoo (NASDAQ:TZOO) soar to new heights every day and not want to be a part of it, or think you're catching a Wal-Mart (NYSE:WMT) on the ground floor. But we're talking about investing our hard-earned money, not chucking a penny into a wishing well.

You wouldn't hike into the Grand Canyon without understanding that the hike back up will be harder than going down. Thus, you shouldn't be tempted to bite at a stock that has only one great metric -- in this case ROE -- going for it.

I sold my shares a few minutes later, but I am keeping a close eye on Timberland. As often happens with quality companies, sometimes their stocks sell off for reasons that aren't material to their business. It's exactly that kind of event that just makes me reach deep inside this pricey pair of boots and find a gem tucked inside.

If you're interested in how Tom Gardner's Hidden Gems recommendations have returned an average of 30% over the past 16 months (vs. a 3% S&P 500 gain), try a 30-dayfree trialto his newsletter -- no strings attached.

Fool contributor Lawrence Meyers owns no companies mentioned in this article. The Motley Fool is investors writing for investors.