When I recommended Office Depot (ODP:NYSE - news - commentary - research - analysis) in my Top 10 Turnarounds column last December at $6.94 a share, virtually every conceivable negative was priced into the stock. I said at the time that the company had been "left for dead." But Office Depot has proved to be very much alive, rising about 115% since that column.

The company's story is simple enough. Led by CEO Bruce Nelson, who took over last year, the company has completely remerchandised its stores, shifting away from a technology-centric model to a focus on the core office products and supplies that small businesses need. While the domestic market is mature, international growth opportunities are substantial, with benign competition and high margins as much as double that of the domestic business.

Oracle Glenn Curtis and Jim Seymour Homestore.com Glenn Curtis and George Mannes Liz Claiborne Arne Alsin and Tim Arango Microsoft Joe Bousquin and Tero Kuittinen Motorola Tish Williams and Tero Kuittinen

Office Depot also has impressive financial strength, providing a reasonable margin of safety for investors: Net current assets exceed all debt by about $250 million, and free cash flow is substantial ($200 million in 2001).

Is Office Depot Still a Buy?

Now that Office Depot has more than doubled in less than a year, what should an investor do? Is there sufficient reward to justify buying at the current quote of about $15? A quick valuation of the company suggests that it is reasonably valued at this price, which is roughly 19 times the current year's depressed earnings of $0.75.

The price-to-earnings ratio is high, but not outrageous on either an absolute or relative basis. As readers of mine know, though, I put little credence in a P/E because it is simply a snapshot of current business conditions. Much more important to me are the prospects for a company -- and for Office Depot, they are bright.

Margin Leverage

In my March column, Keys to Successful Investing, I first mentioned the concept of margin leverage, the ability of a company to lever improvement in profit margins to propel earnings and the stock price. As I pointed out in that column, a company like Microsoft (MSFT:Nasdaq - news - commentary - research - analysis) has virtually no margin leverage. With net margins at roughly 40%, there is no room for significant increases in margins -- and, correspondingly, plenty of risk of a decline in margins.

Office Depot, on the other hand, has impressive margin leverage, with the potential to almost double net margins from 1.6% to 3.0% in the next couple of years (as recently as 1998-1999, the company's net margins were at 3.4%). At 3.0% margins, that would boost earnings to $1.30 to $1.50 and lift the stock value into the low 20s, providing current shareholders with ample appreciation.

Staples

Contrasting Office Depot, which is No. 1 in the category, with runner-up Staples (SPLS:Nasdaq - news - commentary - research - analysis) also suggests a potential valuation for Office Depot in the 20s. Both companies have similar financial strength, and both companies have a business model that yields potential net margins in excess of 3%.

Office Depot is behind Staples in margin performance, but it's clearly catching up and can conceivably match Staples in performance in the next year or so. If and when it does, a comparable valuation based on revenue would lift Office Depot stock to $24-$25 a share. Not bad, especially for a company considered "DOA" just last December.

Who won today's Face-Off? Arne Alsin Chris Edmonds See Results