Blue Nile (Nasdaq: NILE), the largest online diamond and jewelry retailer, reported fourth-quarter results last night that did little to impress shareholders. The company reported a quarterly profit of $0.41 on revenue of $114.8 million, versus consensus estimates of $0.43 on revenue of $110.6 million. Even more disturbingly, first-quarter guidance fell well short of expectations, with Blue Nile forecasting earnings of $0.14 to $0.16 on revenue of $76 million to $78.5 million, compared to consensus expectations of $0.20 on revenue of $79.7 million.

Blue Nile was uncharacteristically quiet about the reasons for its lower-than-expected forecast, but it did predict a vague double-digit increase in revenue and EPS in 2011. Although Blue Nile didn't divulge the reasons behind this apparent slowdown, I have three ideas why the company may be losing its luster.

Rising diamond prices
Blue Nile appeals to consumers because it lets them surf through a vast list of high-end, laboratory-graded diamonds from the convenience of their homes. For investors, Blue Nile's competitive advantage lies in the millions of dollars it need not tie up in idle inventory. Its constantly updated diamond vendor lists allow Blue Nile to purchase diamonds only when needed, which typically translates into lower-priced diamonds than those offered in brick-and-mortar stores.

On the other hand, that lower overhead might have created a false sense of security. Diamond prices are on the rise again, and with Blue Nile's low to mid single-digit margins, the company could be pricing its diamonds too cheaply for current market conditions.

The company also sells a wide swath of gold and platinum engagement rings alongside its diamond selection. In the past year, both gold and platinum spot prices have risen by double-digit percentages. Couple this rise with Blue Nile's razor-thin margins, and it's possible that the company's margins are getting squeezed even further.

Rising expenses
Blue Nile did state that fourth-quarter expenses rose by $2 million year over year, mostly because of increased ad spending. That's particularly interesting because brick-and-mortar competitors Zale (NYSE: ZLC) and Signet (NYSE: SIG) have both closed a sizable amount of stores over the past two years, yet their same-store sales have risen strongly in the most recent quarter.

In other words, Blue Nile is competing against fewer stores, yet still struggling to maintain its growth rate. Zale and Signet are both discount retailers, so it's possible that consumers are taking a more cost-conscious route when purchasing diamonds. Then again, Tiffany's (NYSE: TIF) quarterly report showed strength in high-end consumer buying, with an 10% same-store sales increase. Discount retailers are strengthening, as are high-end retailers, but it appears that Blue Nile's ad spending isn't doing the trick.

At 49 times forward earnings, with a cloudy margin picture, I'm going to have to say no to Blue Nile at these levels.

What's your take? Does Blue Nile just need a good steam cleaning or is there a big flaw analysts are missing? Tell us in the comments section below!

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