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Why Urban Outfitters Will Be Back-of-the-Closet

Clothing retailer Urban Outfitters (URBN) is popular on Wall Street now that it’s hitting the fashion trends and reporting the kinds of numbers that often drive share prices higher, as seen in a stock chart. But how do we know it isn’t just the next Aeropostale (ARO)?

URBN Chart

URBN data by YCharts

The sad story of Aeropostale serves as the cautionary tale for any investor hoping to cash in on popular fashion. Aeropostale shares once represented a stellar investment play on the shopping habits of recession-shocked teenagers (and the parents thereof), rising some 150% between the end of 2008 and mid-2010. For a while, it seemed every 14-year-old girl went off to high school with “AERO” emblazoned across her chest and butt.

Then, suddenly, they didn’t. Aeropostale’s customers moved over to rival brands like American Eagle (AEO) and Abercrombie & Fitch’s (ANF) Hollister. Endless promotions, not unlike those that afflicted J.C. Penney (JCP) before Apple Guy tossed them, have plagued Aeropostale ever since. Revenue growth came to a screeching halt and profit margins tanked. Analysts bailed. The shares lost some 60% of their value in three years. They remain unloved, trading in a narrow range since August, we see in a stock chart.

ARO Revenue TTM Chart

ARO Revenue TTM data by YCharts

Urban Outfitters used to be in the same boat, making bad bets on particular fashion trends and suffering the general malaise of retail in a rough economy. But lately, Urban Outfitter has done well for itself courting a coveted demographic – a sort of rich hipster set that pays $30 for a ratty tank top or $300 for a quirky necklace. Its stores, which include Anthropologie and Free People brands as well as Urban Outfitters, reported high single digit comparable sales in the most recent quarter. Its profit margins have been widening.

URBN Gross Profit Margin TTM Chart

URBN Gross Profit Margin TTM data by YCharts

But the fashion cred that creates those nice margins can be fleeting even for the best retailers. Abercrombie & Fitch raked in cash throughout the recession -- and more than tripled its share price between 2009 and mid-2011 -- by ensuring that almost every customer left its stores boldly advertising the brand. The youngsters eventually grew weary of all those Hollister t-shirts, and Abercrombie profit margins suffered. Similarly, the Gap (GPS), which dressed huge swaths of college campuses back in the day, suffered a share-price depressing dearth of fashion clout for a lot of years before regaining style last year.

Today, Urban Outfitters shares trade at a considerable premiums to competitors, with a PE ratio of about 24, because investors are confident it will continue to attract those upper middle class shoppers, a group that represents a sweet spot for retailers in today’s economy. Analyst forecasts same store sales gains of about 6% this year to help propel earnings about 17% higher.

How can you know that Urban Outfitters won’t blow it with a bad guess about what their customers want next season? You can’t.

Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at editor@ycharts.com.

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