The Right Way to Invest in Cool

Investing in "cool" can be highly profitable, but you also have to be careful not make the wrong decision. In this environment, trends change quickly. This can make it difficult for Foolish investors to invest in the retail space but fear not for their is hope. 

Recent results
Quiksilver's (NYSE: ZQK) third quarter net revenue slid 3% year over year to $496 million. Geographic breakdown:

• Americas: net revenue down 6% ($18 million)
• Australia, Japan, New Zealand, Indonesia: net revenue down 12% ($8 million)
• Europe, U.K, Russia, South Africa: net revenue up 6% ($10 million)

Weakness in the Americas segment related to lower wholesale sales, primarily due to weakness in DC and Quiksilver brands. However, Roxy has performed well in the Americas.

In Australia, Japan, New Zealand, and Indonesia, the weak performance was heavily tied to an unfavorable currency impact of $8 million. To a lesser extent, Quiksilver and Roxy brands have been weak, but the DC brand has been strong, and e-commerce has been a bright spot. Breaking down the geographical performance of this segment, Australia and New Zealand have been the weakest. 

A big part of the impressive performance in the last segment relates to a $6 million foreign currency impact. That said, e-commerce and retail have showed promise, and DC and Roxy brands have been strong in wholesale. Geographically, France and Spain have been the biggest drags on the segment.

Quiksilver states that emerging market revenue jumped 21% in Brazil, Mexico, Russia, Taiwan, Korea, China, and Indonesia, on a constant-currency basis.

Presently, 60% of Quiksilver's revenue is international. So, if you visit the beach or mountains in the continental United States and notice outdoor enthusiasts sporting other brands, it's not a reason to panic. Consumer trends vary greatly from one country to another, and Quiksilver's exposure to 90 countries should be looked at as a big positive. However, negatives might outweigh positives.    

A peer with more promise
Quiksilver is capable of getting its act together. All it takes is an effective marketing campaign to once again win the hearts of teens and young adults. However, at the moment, Tilly's (TLYS 1.19%) is outperforming Quiksilver -- at least in the real world. If you look at stock performances over the past year, you would find a much different story. But Foolish investors know that investing in the strongest underlying business will almost always lead to the best long-term investment results. 

Tilly's also targets teens and young adults. Ironically, it carries the Quiksilver and Roxy brands, as well as other popular brands such as Volcom, Hurley, Dickies, Skin, Fox, Billabong, and much more. Tilly's has also grown to offer casual clothing, footwear, and accessories to those who like to skate, ride motocross, and simply look cool. 

Unlike Quiksilver, Tilly's saw revenue increase in its latest quarter, with sales jumping 17% in the second quarter. Comps declined 0.5%, but Tilly's expects comps to grow in the low to mid-single digits for the fiscal year. Tilly's has also maintained its full-year earnings per share guidance of $0.76-$0.82. While maintained guidance is a positive, this would still represent a decline over last year, when it delivered EPS of $0.92.

If you're looking for a company that successfully markets cool, then you will have to pack up your surfboard or snowboard and look toward a company that targets the everyday teen, young adult, and beyond. Urban Outfitters' (URBN 4.64%) stock has grossly underperformed Quiksilver and Tilly's over the past year, but Urban Outfitters is clearly the top performer in the real world.

Urban Outfitters is highly diversified, targeting ages 18-45 as well as the home & garden and wedding party markets through its various brands: Urban Outfitters, Anthropologie, Free People, Terrain, and BHLDN. Urban Outfitters is growing its top line via store, online, and direct-to-consumer expansion while also driving its bottom line via optimized inventory levels and lower markdowns.

For an example of how these three companies have performed on the top and bottom lines over the past five years, consider the charts below:

Top-line:

ZQK Revenue TTM data by YCharts

Bottom-line:

ZQK EPS Diluted TTM data by YCharts

Tilly's has grown the fastest, but only Urban Outfitters is consistent in both areas. Quiksilver has been left in the dust.

Now consider some key metrics:

Not only does Quiksilver underperform its peers in regards to turning revenue and investor dollars into profit, but it's highly leveraged, and it's trading at 39 times forward earnings. It would make a lot of sense to pay a cheaper price for a company with stronger real-world performance and fundamentals, which pertains to Tilly's or Urban Outfitters.

Don't invest quickly
While Quiksilver is capable of a turnaround, it's underperforming Tilly's and Urban Outfitters in most areas. In such a unpredictable macroeconomic environment with a cautious consumer, you should be better off investing in a company with strong fundamentals and a broad target market.