When I wrote “What’s Shiny and Dropping Like a Rock?” in January, I didn’t know that my bearish take on diamonds would be coming out simultaneously with a number of analyst reports that were bullish on the gemstone’s price for 2012. Nevertheless, I put my voice out there, and so far I’m right.
The first piece of evidence came with Blue Nile (NASDAQ:NILE), and its ferociously poor earnings report in mid-February. How bad was it? Estimates were for net income of 42 cents per share, but it came in at 30 cents, down 32% year over year. And revenues of $112 million came in almost 10% light. This was also a 2.1% decrease year over year.
The news won’t get any brighter for 2012, during which the company says to expect Q1 earnings of 4 cents to 7 cents per share, below the 17 cents forecast by analysts. For the full year, Blue Nile guided to 70 cents to 85 cents, instead of the expected $1.06.
The stock dropped 10% on the news, and another 3% since then.
In January, I had pointed out that with diamonds now becoming ubiquitous, particularly online, that they were in danger of becoming commoditized. As Blue Nile seeks to undercut its competition with lower prices, the only one getting hurt is itself.
You’d think that the company’s strategy, which involves purchasing inventory only when a customer actually buys a diamond from it, would work better than it has. After all, it’s very similar to the build-to-order Dell Computer (NASDAQ:DELL) model.
But I’ll tell you what I think the problem is here: Diamonds are all about marketing. They have no intrinsic value, and their status as a precious stone was manufactured by the geniuses at DeBeers. The diamond mystique depends on the buying experience and the meaning derived from it.
That’s why Tiffany (NYSE:TIF) has remained such a powerful and lucrative brand all these years. But Blue Nile eliminates the specialness of the buying experience, unintentionally focusing customers on the fact that they’re basically buying a pretty rock at a discount price. It lacks magic and romance. Maybe that’s why Tiffany’s margins are three to four times higher than Blue Nile’s.
Another factor is also at play. Despite diamonds’ intrinsic worthlessness, public perception is that they do carry value — but not in the same way that gold does. Gold is considered, for whatever reason, as actually having real tangible value.
So a liquid market exists for the yellow metal in the form of stocks and exchange-traded funds, whereas the market for diamonds is extremely illiquid. If you buy a diamond from Blue Nile, then turn around and try to sell it, you’re going to take a loss. Nobody will pay you more for it, not on eBay (NASDAQ:EBAY), not at your downtown diamond dealer, and not in a pawnshop.
But you could buy a block of gold at a Bullion Express store owned by DGSE Cos. (NASDAQ:DGSE), and then probably sell it for close to 99% of your purchase price. That’s why there’s less risk in going with a gold stock like DGSE or an ETF like SPDR Gold Shares (NYSE:GLD) than a pure-play diamond merchant like Blue Nile.
As one of the villains in the James Bond flick Diamonds Are Forever put it: “Curious…how everyone who touches those diamonds seems to…die.”
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Capital, Inc., which brokers secure high-yield investments to the general public and private equity. You can read his stock market commentary at SeekingAlpha.com. He also has written two books and blogs about public policy, journalistic integrity, popular culture and world affairs.