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We all know that man's best friend is a canine -- but could Fido be man's best financial advisor, too? Well, probably not, but your furry pal can lead you to superior investment ideas. So sit ... stay ... and read on to find out why Fido and I think PetMed Express (Nasdaq: PETS) is better than a bowl full of Milk-Bones and Snausages.

Fast facts on PetMed Express:

Market Capitalization

$363.3 million

Industry

Your furry little friend -- pets

Revenue (TTM)

$235.5 million

Earnings (TTM)

$25.2 million

Source: Capital IQ (a division of Standard & Poor's). TTM is trailing 12 months.

We love our pets
The numbers are big:

  • 71 million U.S. households own a pet.
  • 62% of all U.S. households own a pet.
  • We spent $45.5 billion on our pets in 2009 and will spend $47.7 billion this year.

To put that in perspective, Americans will spend as much on pets in 2010 as the Dominican Republic will produce as a country. If Fidoland were a country, it would have the 74th largest gross domestic product, ahead of countries like Costa Rica and Jamaica (combined). With all silly comparisons aside, the point is that the pet market is bigger than Clifford and a potential gold mine for investors.

PetMed Express fills the prescription
Of the $47.7 billion spent on pets last year, $3.7 billion went toward medication. Ten years ago, this market was a near monopoly controlled by veterinarians. The model was simple: When you took Fido for a checkup, your vet would write a prescription and fill it right there. As a pet owner, you were a price taker because you didn't have any other way to fill the prescription.

Enter PetMed Express. The company operates an online and mail order pet pharmacy. Through its website, catalog, and unforgettable phone number (1-800-PetMeds), PetMed Express sells prescription and nonprescription pet medications, generally at prices well below what your vet charges. Typical of an online retailer, the benefit offered to customers is cost savings and the convenience of anytime ordering and home delivery. But PetMed Express goes even further -- it reminds you when Fido is running out of medicine and will call the vet for you to refill the prescription.

Pet owners have embraced and come to love the service PetMed Express offers. Sales, profits, free cash flow, and customer growth have been impressive over the years. Importantly, the company appears to be keeping existing customers happy (reorders make up 75% of sales) while focusing on attracting new customers and growing the business.

 

FY 2005

FY 2010

5-Year CAGR

Sales

$108.4

$238.3

17.1%

Net Income

$8.0

$26.0

26.6%

Free cash flow

($2.4)

$23.8

NM

New Customers

510,000

815,000

9.8%

Source: Capital IQ and company filings. Numbers in millions, except for customers.

Way back in 1996 PetMed began its quest to bust the vet monopoly. It took awhile to gain some traction, but the company now has 6% market share and getting larger. It dominates the mail order business -- all of its competitors only control 5% of the market. That's right, PETS is larger than all of its mail order competitors combined.

Beware the dog catcher
Let's not confuse a Chihuahua for a mastiff, though; vets still control 72% of the pet medication market. And since PetMed Express has generated a return on equity above 30% for each of the past nine years we shouldn't be surprised if competitors come around and start sniffing under its tail. Major sellers of nonprescription meds and other pet supplies, such as PetSmart (Nasdaq: PETM), Wal-Mart (NYSE: WMT), and Amazon.com (Nasdaq: AMZN), are already competing with PetMed Express. However, PETS has the advantage of being a licensed pharmacy in all 50 states, which allows it to deal in prescription medications, where these others can't. The extra regulation that comes with being a pharmacy, combined with the 1-800-PetMeds brand and high customer satisfaction has built the company a competitive advantage. It is why PetMed is so much larger than its nearest direct competitor, Drs. Foster & Smith, and why I think it will be able to defend its niche against the big dogs.

Many investors disagree with this assessment; Shares of PetMed Express are heavily shorted. Even so, the company has the ability and wherewithal to back up its bark. With no debt, a long-tenured management team and a rabid customer base, The Motley Fool is ready to lift its leg and mark its territory by placing real cash behind PetMed Express. Check back to see how PETS and the other stocks in our "11 O'Clock Stock" campaign are faring.

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