The Fastest-Growing Companies That Could Destroy Investors

We'd all like to pick up shares of the fastest-growing companies, right? The opportunity to buy a company that is selling 30% more than the year before sounds like an investment home run.

Unfortunately that's not always the case, and I'm here to encourage investors to look past the excitement of "The Fastest Growing!" banner hanging on whatever company they're looking at, and take a real look at the numbers to determine if the growth makes sense.

Hang 'em out to dry
Joe's Jeans (Nasdaq: JOEZ) is a great example of a top grower that could be a portfolio anchor. I was reviewing RetailSails.com's report on 2011 chain store productivity and there was Joe's Jeans, ranked as the second-fastest-growing retail chain with a 115% change from last year.

To clarify, RetailSails calculated Joe's performance using May 2011 figures. Though, Joe’s most recent growth by Retailsails.com's metric, which tracks the trailing four quarters, was a still-lofty 58%. Also, RetailSails.com measures brick-and-mortar retail sales, excluding direct-to-consumer and wholesale.

Despite wholesale comprising 88% of Joe's revenue, sales have steadily declined from their 2009 high. Also, though retail only made up 18% of sales in the most recent quarter, the segment contributed 31% of the gross profit. As retail sales increase in importance for Joe's, I don't want to see investors get swept away by deceptive growth figures.

At first blush 115% and 58% growth in brick-and-mortar seems very impressive, but figures can lie. In Joe's case, this monster growth came from adding new stores, not same-store sales at existing locations. This is important because it's same-store sales that indicate whether an idea is resonating with consumers, as opposed to adding new locations. New stores can boost a company's revenue, even when stores open for more than one year flounder with lower traffic and stale products.

Regarding this performance, Joe's writes: "The primary driver for this increase was the positive impact of additional sales due to the opening of seven additional stores between the end of the third quarter of fiscal 2010 and the end of our third quarter of fiscal 2011." Considering that Joe's operated only 17 stores at the end of fiscal 2010, you can see how adding only a few stores has a dramatic impact on sales.

Taking a step back, we see that same-store sales decreased to low single digits. According to RetailSails.com, average sales per store fell 13.7% last quarter, second only (in the apparel segment) to Coldwater Creek's (Nasdaq: CWTR) 23.1% decline over the same period. That's not the sort of performance I'd like to see out of a company supposedly growing at 115%.

We're the best! ... At stretching the truth
These deceptive metrics are all over the retail world. My favorite offender, hhgregg (NYSE: HGG), isn't being bashful, either. The company's own website proudly declares "hhgregg is the fastest growing national retailer of brand-name appliances and electronics with the largest selection."

While there is truth in this, as hhgregg cracks the top 20 on RetailSails' fastest-growing ranking, we know by now that this enthusiasm can be misleading.

hhgregg saw net sales jump up to $619 million in September, a 29% increase over $481 million last year. But once again, this was more due to the addition of more locations than to true organic growth. For the three months ended Sept. 30, 2011, same-store sales increased 1.5%, not even outpacing U.S. inflation. Looking at the six months ended the same period, the picture gets worse, with same-store sales down 5%.

Here is a look at the performance of some of hhgregg's competitors each quarter.

*The comparable store sales reported during this period are for the end of fiscal year 2011.
**Best Buy's reported sales for Q4 2010 did not include December.
***The comparable store sales reported here are for the fiscal year 2010.

As you can see here, hhgregg's "fastest-growing" title is more a technical win than a skilled one, sort of like when the other guy scratches on the eight ball. While it is the fastest-growing retailer this quarter, its sales increase still trails inflation, and it's underperformed its peer group in three of the last four periods. Somewhat different fiscal-year definitions skew the figures slightly, but the idea that its "fastest growth" is propelled by new stores and not same-store growth should be clear.

Take a look at the chart below to see how these "fast growers" rewarded shareholders over the past year:

S&P 500 Stock Chart by YCharts

How to invest?
This is not an explicit buy or sell rating on either company, but more of an illustration about why investors need to do their own research and not be charmed by exciting but vague titles like "fastest growing!" Other companies that made RetailSail.com's fastest-growing list that investors may want to consider digging into are Under Armour, lululemon, and market favorite Apple.

Of course, there are real winners putting up genuine organic growth in the retail space as well. To learn about a few, I invite you to take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it you'll see which retailers are able to consistently outperform, and how two cash kings are planning to ride the waves of retail's changing tide. You can access it by CLICKING HERE.