On Thursday, investors sold off Kirkland's (NASDAQ:KIRK) to the tune of 20% (down $1.92 to $7.78). I haven't seen anything move that fast since a Barry Bonds home run ball flew over my head last Sunday! The company, which warned about sales continuing to slow, posted a loss of $0.14 per share for the second quarter. Sales grew 7.3%, but same-store sales, a measure of store productivity, declined 3.4%.

Let's see what led the specialty retailer of home décor to this lowly state.

First, a key merchandising executive resigned a month after the company revised its forecast. Apparently, management decided to revamp its selection of merchandise. Retailers are all about finding the right things to sell to the customers, so it's usually not a good thing when you don't have the things people want to buy. Strike 1!

Second, the company has had to price aggressively to get rid of the bad inventory. As a result, gross margins dropped from 31% to 25%, quarter to quarter, and operating expenses increased from 27% to 28%. Lower margins and higher costs are also not an optimal combination. Strike 2!

Lastly, CEO Robert Alderson got right to the point about Kirkland's difficulties. It saw lower customer volume and lower transaction volume. No kidding! You didn't have anything good to sell. It also said its current inventory mix was not the best it could be. Translation -- we still don't have the right things to sell! But I think the real kicker came from this comment by Mr. Alderson: "We are not optimistic that we can produce positive comparable store sales in the near term." Sorry, Bobby. Kudos for saying it, but no one wanted to hear that. Strike 3! You're out $37 million in market capitalization!

What makes matters worse is when you compare same-store sales to competitors such as Williams-Sonoma (NYSE:WSM) and Pier 1 Imports (NYSE:PIR).

Q4 Q1 Q2
Kirkland's -4.7% 1.5% -3.4%
Williams-Sonoma 4.1% 6.8% 5.0%
Pier 1 Imports 1.6 % -2.7% -1.8%

Fellow Fool Phil Wohl reported that Williams-Sonoma is delivering the goods to investors. And the numbers don't lie!

But wait; Pier 1's numbers don't look much better than Kirkland's. And lots of Fools have been writing about Pier 1 recently. May was a bad month. June turned out better than expected. Then, lo and behold, Berkshire Hathaway (NYSE:BRK.A) announced it purchased 8 million shares. If I remember correctly, that trio of investors tends to buy stocks at decent prices.

So what does that say about Kirkland's?

I am a believer that markets overreact to news of any kind. Kirkland's is now trading at 16 times its earnings estimate of $0.50 per share. But with the company reporting it will open about 40 stores (net) this year, a 14% increase, same-store sales have got to pick up in order for the current share price to be a bargain.

The company has an enterprise value of $148 million and would need to generate $10 million in cash flow to justify a 14% growth rate. And that's not going to happen for a while; the company is burning through cash right now. So even though the company is trading 65% below its 52-week high, I don't think it's a bargain. With the uncertainty surrounding merchandise and same-store sales, I do not think you have any margin of safety in today's price.

However, I recommend Fools keep their eye on this one. The merchandising problem can be solved. But I don't want to put any pressure on the new merchandising executive to turn same-store sales around by getting products people want to buy!

Fool contributor David Meier has a bunch of furniture from Pottery Barn of Williams-Sonoma, and a new Pier 1 opened up just down the street from his house. He doesn't own shares in any companies mentioned.