Ignoring The Blue Nile Bears

In marked contrast to my prior article where I discussed a short stock, in this article I discuss a stock that I am long, which is perceived by many as being overvalued. The stock is Blue Nile, Inc. (NILE).

According to Yahoo Finance, Blue Nile sports a forward P/E ratio of 52.9, a high measure for most companies. When considering this high P/E value, however, you need to consider the company's strong growth rate, again according to Yahoo Finance, the quarterly revenue growth rate (yoy) is a robust 34%. In that context, the company's forward P/E is high, but not outrageous.

Some of the recent criticisms of the stock have been that a) Amazon (AMZN) might enter the picture, b) insider selling foretells of a lack of confidence, and c) generally lower margins, higher costs, and increased competition.

Yes, Amazon might enter the picture in a substantive manner. Amazon already sells jewelry, but that, so far, is not having much of an affect. If Amazon were to become a more online jewelry force, Blue Nile would reduce its margins even further and both Amazon and Blue Nile would find it tough sledding. Zale Corporation (ZLC), however, would find the extra competition absolutely brutal, especially considering that it is having a tough time right now. I am short Zale.

I do not believe that the recent insider sales indicate management's lack of confidence. Using Yahoo Financial, I note that many of the insider trades are automatic sales. That means that the sale was affected pursuant to a Rule 10b5-1 trading plan adopted by the reporting person. The sale would have happened regardless of the most recent financial results, which were strong.

Moreover, most of the senior management team are young and this is likely their first taste of significant wealth. Having lived through the turbulent markets around the year 2000, they are financially prudent and are ensuring that their financial future is secure. I do not see any issue surrounding insider sales.

I am not, at this point, concerned about the company's margins. The company purposefully lowered its margins to increase sales even faster. Blue Nile is enjoying success with its program as indicated by its raised guidance. Higher costs and increased competition are simply part of being in business. Thus far, Blue Nile is enjoying strong growth with no strong online competition. While there is always the threat of Amazon or others entering the fray, Blue Nile continues to get stronger. The question then becomes, do you sell now out of fear of what might happen or do you continue to monitor the situation closely and take action when necessary?

None of those arguments convinces me to sell Blue Nile. One interesting observation is that the short position in Blue Nile, according to Yahoo Finance and ShortSqueeze.com, has decreased roughly 900,000 shares from 4.0 million to 3.1 million shares. The short 3.1 million shares translate into a short ratio of about 23 days. Given Blue Nile's recent strong stock performance, I am not surprised that many shorts have reduced or eliminated their positions. I am curious if the shorts will reload again shortly.

In summary, the bearish articles on Blue Nile have not swayed my positive belief in the company's future performance and growth. The company's conference call (courtesy of Seeking Alpha) demonstrated that management is exceeding its expectations and that management was able to raise guidance. While I am positive on the company's future, I am not a raging bull because the valuation is rich. If I were initiating a position, I would do so over a few weeks in case there were a stock price correction. Given that I have a full position, I am inclined to keep my position and await the next quarterly conference call.

Disclosure: I am short Zale stock and long Blue Nile stock.

NILE vs. ZLC 1-yr chart: