Dueling Fools: Blue Nile Bear

In retailing, the three things that matter most are quality, service, and price. Online retailers are ordinarily at a disadvantage to their brick-and-mortar counterparts when it comes to service. After all, you don't get to touch the merchandise before purchasing it, nor do you get the instant gratification of taking home your items the very same day. The most successful online firms, such as Amazon.com (NASDAQ:AMZN), make up for that shortfall by aggressively competing on quality and price; their scale helps hold down prices, while their centralized operations provide better selection.

Having been a satisfied Amazon customer for years, I believed that the Internet would provide a great opportunity to buy quality jewelry at a discounted price. As a result, the very first pair of diamond earrings I bought for the woman who is now my wife came from online jewelry merchant Blue Nile (NASDAQ:NILE). While Blue Nile sold me a very fine pair of earrings, a friend later told me about a nearly identical pair that he bought at a local merchant, EDB's Diamond Showroom, substantially below Blue Nile's price.

When it came time to take the plunge and buy her engagement ring, I comparison-shopped Blue Nile vs. EDB's. For an identically graded stone, EDB's price won, hands down. The fully loaded cost of my wife's engagement ring, including the platinum band, regular checkups, a cleaning kit, and sales tax, came in several hundred dollars below Blue Nile's price for the stone alone. Add in EDB's offer of six months' same-as-cash financing vs. Blue Nile's three months, and EDB's won my business. Sure, the Blue Nile price may be lower than upscale retailer Tiffany's (NYSE:TIF), but with Tiffany, you're intentionally paying for that name and the famous little blue box.

Overpriced merchandise, overpriced stock
With luxury merchandise like diamonds, customers might be willing to pay up for quality. For investors, however, the key lesson we teach at Motley Fool Inside Value is that we should never pay up for a stock. Companies have a true worth, and our goal as investors is to find and buy stocks trading substantially below that number. One way to estimate that worth is to compare a company to other firms in similar business lines. Blue Nile can be compared to other general and focused retail outlets to see how it stacks up as a potential investment. This chart shows an at-a-glance comparison of Blue Nile to a few other firms that specialize in selling you stuff:

As you can see, Blue Nile drastically trails the competition from a value investor's perspective. I'll concede that it may deserve a higher P/E ratio than the comparable firms due to its faster expected growth. Looking at the P/E-to-growth (PEG) ratio, however, shows that its expected growth is priced at a higher premium than those other companies. When (not if) that growth decelerates, or if the company slips up along the way, its shares have that much farther to fall. To make it an even riskier place for your money, Blue Nile pays no dividend. From a value investor's valuation perspective, there are simply greener pastures elsewhere.

The Foolish bottom line
As a retailer, Blue Nile fails to beat a brick-and-mortar alternative on the three key facets of price, quality, and service. As an investment, it's priced to perfection in a market where many bargains are not only waiting to be found, but are willing to pay you for holding them. Looking at the company from a risk-adjusted reward perspective, Blue Nile is simply tilted way too far towards risk, with not enough opportunity for reward.

But, wait! You're not done. This is just a quarter of the Duel! Don't miss Nathan Parmalee's bullish argument, Chuck's bearish rebuttal, and Nathan'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.

The Motley Fool has kicked off its ninth annual Foolanthropy campaign! Nominate your favorite charities on our Foolanthropy discussion board through Nov. 1. For guidelines on what makes a charity Foolish, visit www.foolanthropy.com .

At the time of publication, Fool contributor and Inside Value team member Chuck Saletta owned shares of Lowe's. Blue Nile is a selection of both Motley Fool Hidden Gems and Motley Fool Rule Breakers. Best Buy and Amazon.com are Motley Fool Stock Advisorpicks. The Fool has adisclosure policy.