A Diamond Among Diamonds

Blue Nile (NASDAQ:NILE)
trading at $34.97 as of 10/25/04

You can have your Ring Pops and candy necklaces. This Halloween I'm opening my treat bag wide for fancier jewels. Blue Nile knows what I'm talking about. It has used its online storefront to move more than 50,000 diamond engagement rings.

It went public at $25 a stub back in May, and it's got all of the traits one would like in a post-bubble dot-com company. It's profitable. Sales were up 36% through the first half of the year. While one would think that the barriers to entry would be low, even Amazon (NASDAQ:AMZN) respects Blue Nile's turf as its fine jewelry offerings cater more to its mainstream customers. Blue Nile, on the other hand, is averaging $1,300 an order.

You almost have to feel sorry for Amazon, shipping out bulky items for free on many orders over $25 while Blue Nile can FedEx (NYSE:FDX) its compact, high-end jewelry for free, put out a 30-day money-back guarantee (so if you don't hear "I do" you won't be saying "I due") and still carve out healthy profit.

However, it's not as though Blue Nile shoppers are being ripped off. They are getting customized jewelry, and all of the savings that Blue Nile achieves -- from its lack of brick-and-mortar overhead (it will claim just $2 million in capital expenditures this year) to its rock-bottom pricing thanks to its consumer-direct approach -- are passed on to the customer. While Blue Nile is able to achieve gross margins of 23%, their customers are still able to save a lot of money.

Last month the stock was singled out as the first recommendation in our new Rule Breakers newsletter. Finding great growth stocks early in their life cycle that just happen to be butting heads with conventional wisdom is clearly a risky playground. Thankfully the potential rewards are also great.

So what can investors expect trolling the waters of Blue Nile? Reinventing the nervous wedding proposal on bended knee may seem like a tough jewel to crack for the company. Don't we all want to run off to the local jeweler when the matrimony bug bites (and as a married Fool, believe me, that bug gnashes away with sharp, unforgiving teeth)? Don't we all want to stumble our way through feigned interest and blank comprehension when all that really matters is that the rock you're buying will make your potential fiancée happy?

Perhaps that's why the site's effective tutorial on choosing the right engagement ring is so conducive to closing the deal with the company. The fact that you're getting a discounted price and saving even more by getting a break on sales tax (which really adds up with these big-ticket purchases) is huge. So is the fact that you can arrange for MBNA financing on the spot.

The company is trading at a conservative estimate of less than 20 times next year's potential free cash flow. That's certainly reasonable for a company growing by 25% every year and with so much of the "Marry Me" market left to tap.

But won't the competitors storm the engagement party if offline customers migrate to Blue Nile? If it ever comes to that point it would probably be a great problem to have. Blue Nile would be either an attractive acquisition for an offline giant such as Zale (NYSE:ZLC), or it will continue to win over new customers as the first mover in a simple model that is as brilliant as perfectly set diamonds on a ring that promises neverending tomorrows.

More Motley Fool Tricks and Treats:

Longtime Fool contributor Rick Munarriz loves Halloween. He's a sucker for all things chocolate and Lemonheads. He does not own shares in any of the companies mentioned in this story.

The Motley Ghoul's Tricks or Treats represent the opinions of each Fool only and should in no way be taken as the opinion of either The Motley Fool, Inc. or any company in question, or as representative of anyone or anything other than that specific Fool's thoughts. So do your homework, and review The Motley Fool's disclosure policy.

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