Nearly a year ago, I took a Halloween look at Abercrombie & Fitch (NYSE:ANF) and pronounced it a real treat. I followed up on this pronouncement by forgetting to buy the shares myself. I've been sitting on the sidelines, biting my nails, while the stock has run from $37.16 to $65.11 today. That's 75% in 10 months, for those of you keeping score.

The squishy bit
One of the reasons I was high on Abercrombie back then was that my wife, who's a teacher, reported that plenty of kids were sporting A&F clothes at school. That suggested to me that the sales slump at the time would be short-lived.

Let's be honest -- kids love wearing this stuff. They like to look as if they come from old East Coast money. They like to pack themselves into tight tees, short-waisted pants, and insufficiently buttoned blouses to show off their newly acquired bods. And they've got a pretty good allegiance to the real thing.

Competitors like Aeropostale (NYSE:ARO) and American Eagle Outfitters (NASDAQ:AEOS) can nip at Abercrombie's heels, but they're working at the lower price points. We all know that even impecunious teens and 20-somethings will pay up for the brands they hold dear. (This is America, after all.)

Don't believe my meandering rant? Just consult the numbers to see how things have turned around. May's overall sales increased 43%, with comparable-store sales up a healthy 29%. June sales jumped 52% over the year-ago period, with comparable-store sales increasing a hefty 38%. In July, that cooled down to a mere 33% sales increase, with comps growth of 22%.

Finally, I firmly expect to see more growth on the top line. It won't be that torrid forever, but Abercrombie's ancillary brands, Hollister and the just-rolled-out Ruehl, offer avenues for the firm to reach beyond its typical customer.

The hard numbers
Anyone can move a lot of product. But Abercrombie does a lot more than that. Its margins are among the best in the clothing business, and at the gross level, they eclipse all peers except for American Eagle.

Margins, last fiscal year Gross Operating Net
Abercrombie & Fitch 45% 17.2% 10.7%
Gap (NYSE:GPS) 39.2% 11.5% 7.1%
Aeropostale 33.2% 14.1% 8.6%
American Eagle 46.7% 19.3%


Urban Outfitters (NASDAQ:URBN) 40.9% 17.9% 10.9%
Industry Average 36% 6.1% 3.6%

Moreover, it's been making steady progress on these lines since a post-2000 slump. In 2002, gross margins dropped to 40.6%, but they've marched back since. Net margins, however, weren't so impressive. That 10.7% mark for last year is nearly four full points worse than what was achieved in 2000. But, paradoxically, that's just another reason I think Abercrombie's worth a look now. There's still room for improvement, and once the firm wrenches up the bottom line -- it's coming in at 13.9% for the trailing four quarters -- it ought to be a catalyst for further gains.

The price tag
With Abercrombie's P/E in the mid-20s, I'm not going to try to argue that the company looks cheap. However, the enterprise value-to-EBITDA ratio of 10.5 isn't too far off the seven-year average of 9.75. It looks fairly valued to me, but I'm inclined to call it a buy anyway, for one simple reason: returns on investment.

Abercrombie's returns on assets, equity, and capital are consistently excellent, and a company with a history of earning 29% on its capital (that's my thumbnailed five-year average) is likely to continue outrunning the market. A&F keeps finding ways to win, despite the occasional sales slide. That's exactly the kind of company that can make you rich in the long run.

For related Foolishness:

  • Abercrombie isn't the only company working against the notion of a much-hyped, but so far unrealized, denim glut.
  • When the Street gets it wrong, consider catching some falling stars.
  • Watch those margins, because the right trend is your friend.

You're not done. This is just one part of a four-part Duel! Don't miss Rick Munarriz's bearish opening salvo, Rick's rebuttal, or Seth's final word. When you're done, you're still not done. You can vote and let us know who you think won this Duel.

Seth Jayson used to think retail was for suckers. At the time of publication, he had shares of Aeropostale, and American Eagle. View his stock holdings and Fool profile here. Fool rules are here.