Chico's FAS

(CHS) - Get Report

was one of a handful of stocks that moved higher during Tuesday's broad market selloff, as the retailer was upgraded from underperform to market perform by the brokerage Friedman Billings Ramsey.

While conceding that "the story is still a work in progress," analyst Adrienne Tennant believes that any disappointing news in the near term has already been priced into the stock, and management is successfully addressing recent inventory growth.

Year-over-year comparisons also are expected to become easier in upcoming months, after Chico's reported five straight months of same-store sales declines.

Chico's shares are up 20.4% year to date, closing Tuesday at $24.90. The company is trading at 21.9 times fiscal 2008 (ending January) expected earnings of $1.14. That said, the stock is currently down nearly 50% from its February 2006 high of $49.40. With that in mind, I'm here to answer readers' questions: Should I do it? Is Chico's once again a fashionable investment, or will the stock not be able to sustain its recent recovery?

The company currently operates 925 casual-wear apparel locations in 47 states under the Chico's, White House/Black Market and Soma brands. Until about a year ago, Chico's FAS was one of the fastest-growing specialty retail chains in the women's apparel market.

For the five years ended fiscal 2006, the company posted 43.7% compound annual earnings growth. During that run, the stock had moved into the high $40s in early 2006 after being in the single digits less than three years before.

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But the air started coming out of the balloon last March, when the company warned that growing investments in its smaller Soma brand would cut into earnings. At that time, the fiscal 2007 consensus analyst estimate for Chico's was $1.32 a share. But by the time the books were closed for the year, the retailer had earned just 95 cents.

Despite this disappointing result, management still has an aggressive growth strategy for the company in fiscal 2008. Chico's is targeting 15% annual square-footage expansion and is planning to open 105 to 115 new locations. While down from its historical growth rate of 22% to 25%, investors buying the stock now need to believe that management can achieve this growth target while simultaneously trying to reverse the trend of five months of declining same-store sales.

Taking that leap of faith and assuming that everything falls into place, the company is expected to post a 20% rebound in fiscal 2008 earnings to $1.14 a share. That said, Chico's already trades at 21.9 times this figure, compared with an industry average price/earnings multiple of 20.2 times full-year earnings.

While discounting prices can help move excess inventory, it doesn't always come cheaply. The company reduced inventory per square foot by 11% in the January quarter, though gross margin also fell to 54% from 59.7% in the October quarter and 59.4% a year ago.

Chico's bulls can take heart that insiders have recently bought stock on the open market. According to

Securities and Exchange Commission

filings, CEO David Dyer purchased 10,000 shares March 23 and director David Walker also picked up 1,000 shares March 15.

Many value investors often believe that insider buying is positive because management arguably knows more about the current strength of a company's business than the average investor.

Even so, history also shows us that management spent $200 million of Chico's cash to buy back 6.7 million shares between March and July 2006, at an average price of $30. Even though Chico's still has a pristine balance sheet, with $275 million ($1.60 a share) of cash and equivalents, clearly that wasn't an opportune time to buy, because the stock fell as low as $17.26 in August 2006.

With that in mind, I believe that readers should pass on Chico's at current levels. The company is still trying to expand its store count past 1,000 this year at a time when its existing locations have not been able to generate organic growth for several months.

While the stock is trading at just half the price it was last February, Chico's has already bounced 20% on the year, and I believe that better values currently exist in the stock market.

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David Peltier is a research associate at In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Peltier appreciates your feedback;

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