I've been watching Timberland (NYSE:TBL) all summer. I've got an "outperform" rating on the company in CAPS to help me keep an eye on it. But I've yet to plunk down any real money on the company, and I don't think you should, either -- at least, not until we revenue stops dropping like a rock, and margins get a significant boost.

Like fellow retailers Borders (NYSE:BGP), Cost Plus World Market (NASDAQ:CPWM), and Pier 1 (NYSE:PIR), Timberland is a turnaround that hasn't turned. Timberland's slide has been long and pronounced. Year over year, quarterly earnings have dropped for six straight quarters -- and counting -- with another poor showing expected in the company's third-quarter earnings release Nov. 1. This has triggered a nasty drop in Timberland's stock; the price is now less than half its all-time high, and shares trade at a four-year low.

Catching the bottom here is a dicey proposition, because all the evidence suggests that things will get worse before they get better. Good luck trying to figure out when that will happen. With situations like this, you're better off waiting until the company shows a quarter or two of improvement, to avoid getting burned by a stock that falls in step with its drops in profits.

Last week, the company lowered its Q3 guidance and announced that it will shut down 40 of its specialty retail stores. Third-quarter revenue is expected to decline by a low-teens percentage, compared to the prior forecast of a high-single-digit decline. There will also be a 600-basis point drop in operating margins. Supposedly, the bleeding will stop in the fourth quarter, with "relatively flat revenues." But because of Timberland's recent lowering of Q3 guidance, and the modest retooling of the business, I'm taking management's future predictions with a grain of salt until business really does stabilize.

Ongoing business troubles aside, I think there are things to like about Timberland, and investors interested in small-cap values should at the very least keep an eye on the company's progress. Here are a few key points:

  1. Insiders control a very large number of shares. The Swartz family, which founded the company, owns more than 20% of its outstanding shares. High insider ownership, particularly by company founders, is something we like to see with small-cap companies at Hidden Gems, since it aligns management's interests with those of outside shareholders. Recent troubles aside, Timberland has excelled under the Swartz's stewardship.
  2. CEO Jeff Swartz has been involved with Timberland for more than 20 years, and he's been sitting in the Chief Executive's chair for almost a decade. He's an experienced leader who's guided Timberland through difficult stretches before. I like CEOs with such strong track records. It gives me confidence in their ability to adapt the company's operations to changing business conditions.
  3. Even though the top line is falling and margins are shrinking, Timberland remains comfortably profitable on an annual basis. Its nearly $100 million cash on hand and lack of debt work in its favor during this difficult period. I have no problem with debt, and I only bring it up since fixed interest payments at debt-heavy companies can come back to haunt those firms when business turns sour. Thanks to Timberland's conservative capital structure, we shouldn't have to worry about that.

Timberland has weathered rough patches before, and it's come through fine. I don't think this instance will be an exception. Its decision to focus on smaller footwear stores is returning the company to basics, emphasizing the products for which the Timberland brand is best known.

On a trailing-12-month basis, Timberland's operating margin sits at 8.7% -- well below its goal of 15%. We already know that the third quarter willbe bad, so we can write that one off, even though results aren't out yet. Instead, investors need to watch for stabilization in the fourth quarter, and then actual improvements in the first half of next year.

If Timberland can get back to where it was, there's a lot of upside to this stock. I think it can double. I recommend sitting on the sidelines for now, though, until improvements in the business are clear.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.