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Is Zale a Jewel for Next Year?

The diamond retailer's stock is off 48%.

It looks like diamonds could be an investor's best friend next year.

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2001: The Return of Graham and Dodd

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Click here to see 2001: New Year, New Rules stories from earlier this week.

The real beauty of a diamond is not in how it looks -- the beauty lies in its high inelasticity of consumer demand. Huh? That means people tend to buy diamonds no matter what the rest of the economy is doing. And even if they skimp a little on how much they spend, that works just fine for




Zale is the country's largest specialty retailer of fine jewelry. With more than 1,400 stores and more than 900 kiosks selling a range of jewelry, Zale just might get all dolled up in the coming year.

The Dallas-based company is taking its lumps this season along with everyone else in the retail game, due to the slowing economic growth and constricting consumer spending. But, according to Jeffrey Stein, managing director of

McDonald Investments

, "This is the premier company in the

retail jewelry business."

But what about the decline of the retail industry in general? "The jewelry industry may prove more resilient to a downturn in spending than people believe," says Stein, adding that he thinks Zale can "improve operations over the next 12 to 18 months and still achieve 20% growth targets without the economy being robust."

The key here is that the jewelry sales base doesn't shift much in either direction depending on the economy. People get married in good times and bad, and they continually create a market for engagement rings, wedding bands and anniversary gifts, according to CEO

Beryl Raff

. The wedding-related market accounts for 36% of Zale's annual business. Holidays such as Christmas, Valentine's Day and Mother's Day, which occur regardless of economic up- or downturn, account for another large segment of revenue.

The File


Business: Leading retailer of specialty jewelry

2000 Revenue: $1.8 billion

2000 Earnings Per Share: $3.10

2001 Estimated Earnings Growth: 21%

Stock Snapshot

52-Week Range: $23.4 - 51

Percentage Change from Jan. 1: -48.4%

Market Cap: 841 million

P/E Multiple: 7.8

Shares Outstanding: 35.2 million

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Even so, the jewelry chain is feeling the harsh hand of the Grinch this season. Last month, in addition to announcing meeting first quarter 2001 earnings estimates, it reduced expected holiday sales gains from 5% to 6% down to 3% to 4%. Also reported was a slower rate of growth for same-store sales, growing 3.3% last quarter compared with 10.1% the same quarter last year.

"There could be some more downside risks because of the fourth quarter, and there's always potential for more earnings revisions," said Richard Zimmerman, vice president of equity research at

Janney Montgomery Scott


In this market, who knows where the stock will go if earnings are revised? "It's a well-run, well-managed company," Zimmerman said, adding that he thinks there is an "upside potential in the longer term," meaning a 12-month time span.

Zale outshines the competition due to its "good-better-best strategy and a wide range of demographics," said Zimmerman. Zale runs retail outlets of varying degrees of customer appeal, from the high-scale, higher-priced

Bailey Banks & Biddle

, to the next lower echelons,

Gordon's Jewelers


Zale Jewelers

. Zale acquired the mall kiosk chain

Piercing Pagoda

back in September, adding yet another range of jewelry and prices to its operations.



But for many pros, the real beauty of this jewel lies in the numbers. "It's trading six or seven times, for a company that's shown decent growth and earnings," said Zimmerman, pointing out that it's trading below its low-end valuation over the past 10 years. Zale's

price-to-earning ratio is actually 7.8 times earnings, but even more remarkable is its

price-to-sales ratio of 0.46. The stock is currently trading in the mid-20s, down 48.4% year to date.

Falling right into our love fest for consistency this week, Zale has maintained a past earnings growth of approximately 20%, has a predicted EPS growth rate of 19% for the current quarter and 21% for the current fiscal year. After the tech ride of 2000, don't you just love the sweet smell of consistency?

"I believe this company is going to surprise people," said Stein. Let's hope it's for the better.

Below the funds holding the most significant portfolio shares of Zale Corp. are listed. With all that we've been through recently, these funds seem to be guessing that they've found a true diamond in the rough.