Who loves ya, baby?
"The trend is your friend." That's a bit of investing Wisdom I've always considered a complete pile of doody. The trend people are talking about in this case is price action. They're saying you should buy what's going up, because it will keep going up, and avoid what's dropping, because it will continue to do so. Whatever. There's plenty of research to refute this sheeplike advice, and my own investing successes come from embracing exactly the opposite tack. But that's another topic.

Watching the right trends
Let's not write off trends entirely. There are trends worth watching, even for cheapskates like me who would rather catch falling knives than buy high and hope for higher. I don't give a whit about short-term price action. What matters to Foolish investors is the trend in the business. A company nosing up from a period of perceived underperformance can be a real Motley Fool Hidden Gem -- just take a look at the 270% ride that Middleby (NASDAQ:MIDD) gave investors after Tom Gardner's recommendation not quite two years ago.

Paradoxically, these kinds of circumstances can be simple to uncover. Margins rank among my favorite developments to watch. Yup, basic Investment 101 stuff. Third-grade math. Don't overlook the easy stuff, Fools. And listen to your wife.

The friendliest trends are overlooked
I've written a lot about Guess? (NYSE:GES) lately, and not just because it's made me a quick 60%. No, what's fun about owning Guess? is how I came across the idea. This is a stock my wife brought to me a few months back. First I scoffed, but after she showed me a few numbers, I embraced it with considerable enthusiasm. It wasn't just a prime example of a company in turnaround -- it was a company that no one was paying attention to, including me.

This was exactly the kind of stock I learned to appreciate under the tutelage of my colleague Bill Mann, current guest stockpicker for Motley Fool Hidden Gems. In fact, its mild sales growth and underappreciated profit potential make it look -- to my eyes -- a bit like his Hidden Gems pick, New York and Co. (NYSE:NWY). While I'm not sure I'd have called Guess? a jewel, I was confident it was something very close -- a very nice-looking but ignored bauble, hidden in plain sight in the manner of Edgar Allan Poe's Purloined Letter.

To summarize, it was the kind of simple but misunderstood situation that Bill, or any clever Fool, would love to stumble across. Guess was in the midst of making impressive operational improvements. Margins were improving due to smarter management and concerted efforts at better sourcing, inventory controls, and attention to store performance. Here's a peek at the trends that mattered to me.

2004

2003

2002

2001

2000

1999

Sales (millions)

$729.3

$636.6

$583.1

$677.6

$779.2

$599.7

Gross Margin

37.6%

34.6%

34.2%

33.9%

36.4%

44.7%

Operating Margin

7.6%

3.2%

-1.5%

3.5%

5.5%

15.6%

Net Margin

4.1%

1.1%

-1.9%

0.9%

2.1%

8.7%


Pay careful attention to what's gone on since 2002. What I liked best about the situation was that very few among the Wise were taking notice. I suspect that's because revenue growth in the 10% to 15% range simply didn't match up with what was going on at hot peers such as Aeropostale (NYSE:ARO) or American Eagle Outfitters (NASDAQ:AEOS). Single-digit comps growth? Who wants that? No one, apparently, although I'm happy to take it when it comes with big gains in profitability, as it did in this case. Guess? also suffered the stink of being yesterday's news. "Please! Spare us your tight buns and legwarmer gear," the Street was saying. "Give us the contemporary allure of Abercrombie & Fitch's (NYSE:ANF) skanky-teen, faux-old-East-Coast-money vibe."

The complexity complex
I'm usually one to avoid overly complex investments, and I've often counseled other Fools to do the same. But in the case of Guess?, I reversed my policy. In fact, the number of plates that are spinning in the air at once remains part of the attraction -- and part of the reason the company still looks undervalued to me. Because it is still in the midst of fairly substantial changes, even the most expert analysts are having trouble keeping everything straight.

Just a few examples of the things kludging up a Guess? analysis:

  • A shifting mixture of retail, wholesale, and license business that makes it tough to compare revenues and margins to prior periods.
  • The acquisition of a European licensee, which exposed the firm to a different retail seasonality than in the U.S., and added a scary-looking slug of accounts receivable.
  • New retail initiatives in both the U.S. and Europe, including experimental stores.
  • New products, including accessories and the high-end Marciano line.
  • An embargo on certain textile products from China.
  • Shifts in sales patterns, fulfillment policies, and retailer purchasing habits that make this year's revenues and inventories not quite comparable to last year's.

What's a Fool to do when faced with such a wealth of worries? I'd start by listening to the quarterly conference calls, where -- to management's credit -- most of this is explained in detail, and better yet, in terms even a simple Fool like me can understand. Next, I'd stop worrying and refocus on the right trends.

Recent second-quarter earnings were another knockout, far exceeding analysts' expectations -- as did first-quarter results. Guess? came up with $0.09 per share, an 80% increase, on top-line growth of 15.7%. The stock popped nicely, but who cares about that? The results showed more improvement in operations, and that matters a lot more to me.

Gross margins were down slightly, but operating margins and net margins both registered nearly 1% gains over the prior-year period. Not bad for a quarter in which the European operation runs at a loss (because of the seasonality of sales there and the fixed SG&A costs). Lean inventory control has led to less discounting, a situation expected to continue, and one I find comforting in a premium retail brand.

And while some chuckleheads out there denigrate Guess? because its margins aren't yet on par with its peers, I say, "Good."

Let them scoff. Let them issue shortsighted sell targets. Because Guess?'s margins are clearly moving in the right direction, and I expect them to arrive there, with more nice surprises for shareholders on the bottom line. Couple this capacity for improved profitability with what I think are underappreciated growth opportunities in North America, Latin America, Asia, and Europe -- regions for which Guess? has recently expanded its strategic management teams -- and I'm convinced that there's plenty more good Guesswork to come.

The Foolish bottom line
We've said before in this space that the obvious can't help you. But as Guess? shows, some pretty obvious clues to good investments can be found in plain sight. Often enough, it's something as simple as improving margins on unexciting sales.

The trends really are your friends, so long as everyone else is ignoring the ones that matter. Keep your eyes on the business and buy what looks strong while others are still scoffing. By the time the profitability becomes two-by-four-across-the-forehead obvious, the latecomers will be lining up to pay top dollar for what you got on sale.

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Seth Jayson has made a career -- several, actually -- by paying attention to the obvious. At the time of publication, he had shares of New York and Co., Aeropostale, American Eagle, and Guess?, but no position in any other firm mentioned. View his stock holdings and Fool profile here. Fool rules are here.