Why the Blue Nile Shorts Are Going to Get Squeezed

I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer, too. But even I have to admit some growth stories are bogus, hence this regular series.

Next up: Blue Nile (Nasdaq: NILE). Is this online jewelry retailer the real thing? Let's get right to the numbers.

Foolish facts

Data current as of Oct. 28.

As with many of our picks in the Rule Breakers service, many of the top value investors in Fooldom eschew owning Blue Nile, a two-time winner for our scorecard. But don't take my word for it. See for yourself:

"Still over-priced even after recent drop. I'm looking for a few consumer discretionary stocks to short to hedge my mostly long CAPS portfolio. [Blue Nile], trading at 36 times its estimated 2011 earnings, versus 14 for a company like Tiffany & Co. (NYSE: TIF), fits the bill nicely," wrote TMFDeej, a confessed dividend hoarder, in August. (Blue Nile doesn't pay a dividend.)

It's been a solid pick in the two months since, but I can see a cover coming before long. Blue Nile isn't a bad business. If anything, it's poised to profit even more as shoppers spend more time online and less time in bricks-and-mortar stores.

What's more, with 34% of Blue Nile's outstanding shares sold short, investors are trading the stock as if there's nothing but bad news on the horizon. Should they prove wrong, the release of that short interest via covering buys would send the stock sharply higher.

The elements of growth

Source: Capital IQ, a division of Standard & Poor's.

Looking at the fundamentals as represented in this table increases my belief a short squeeze is coming. Let's review:

• First, revenue and net normalized earnings aren't just growing, they're accelerating. Growth investors covet this sort of performance.
• Gross margin is nicely stable, a good sign in that it means Blue Nile discounts product because it can -- not because it has to. There's a huge difference.
• If there's an issue here, it's with receivables. We can't expect receivables to grow faster than revenue forever. At some point, Blue Nile has to collect what it's owed.

Competitor and peer checkup

Source: Capital IQ, a division of Standard & Poor's. Data current as of Oct. 28.

Blue Nile's three-year performance helps explain why the stock is down 47% over a period when the market is off 22%. Amazon.com, the top performer in this list by far, has nearly doubled since Halloween 2007.

Grade: Sustainable
And yet if I had to choose between these two, I still think I'd choose Blue Nile. Jewelers will be around so long as couples continue to get married. They'll turn to discounters such as Blue Nile for the best values, and Tiffany for the brand experience. Everyone else -- yes, I'm looking at you, Zale Corp. (NYSE: ZLC) -- has a lot to fear.

Now it's your turn to weigh in. Do you like Blue Nile at these levels? Let us know using the comments box below. You can also ask Tim to evaluate a favorite growth story by sending him an email, or replying to him on Twitter.

Interested in more info on Blue Nile? Add it to your watchlist here by clicking here.