DSW Inc. Sank 5% on Earnings... What's Next for the Stock?

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DSW , the shoe retail giant with more than 300 stores, saw its shares sink nearly 5% on third-quarter earnings that disappointed the Street. Investors are wondering if DSW is a buying opportunity on this drop, or if they should sell shares in favor of rivals like Brown Shoe Company .

Here's a quick look at what happened to DSW, and what you should do with your shares next. 

What happened?
DSW and Brown Shoe Company compete head-to-head with their DSW and Famous Footwear brands. The companies each reported third-quarter earnings Tuesday, with DSW's shares falling on the news while Brown's shares rose slightly.


In its quarter, DSW reported earnings that only met analysts' expectations, yet they were up a healthy 14% from the third quarter of last year; sales also rose 7% year over year. Similarly, Brown's quarter showed healthy earnings growth of 12%, even as sales only increased 1%. 

So why, considering both companies grew EPS, were DSW's shares down?

Comps and expectations
In short, the market was disappointed by how DSW grew its earnings and its outlook. While sales grew an impressive 7%, same-store sales were essentially flat. DSW also said it expects flat same-store sales this year, and it lowered its top-line guidance as well. Dangerous things can happen when retailers continue to grow, via new stores, even as same-store sales slow; with this in mind, it's not surprising that shares slipped. 

While Brown may have showed softer overall revenue growth, same-store sales were up 4.9%, and the company guided earnings up. 

What's next
There are two ways to look at these results. On one hand I feel that the stocks went in opposite directions because DSW only met analysts' EPS expectations while Brown exceeded them. If that were the only reason for the sell-off, it might make sense for you to pick up shares of DSW, because opportunities can be had when the market overreacts to analysts "guessing wrong."

Still, I find it somewhat troubling that DSW's management team expressed that steep discounting was needed during the recent quarter, even as Brown Shoe's group raved over a strong back-to-school season. The fact that DSW's management team doesn't see same-store sales rising for an entire year, yet is still planning to open new stores, worries me a bit. I believe that the worst trap a retailer can fall into is the feeling that they should grow for "growth's sake," by taking on new debt to open stores even as margins are clearly pressured.

Foolish verdict: A good time to hold
I don't think that there is a lot that separates these companies. Both are well-known, well-advertised shoe retailers, with little structural advantages over each other. That's really the biggest reason that I'm surprised at the contrast in third-quarter results.

If you're an owner of DSW, however, I wouldn't sell shares on this news alone. Rather, it's probably a good time to just stand pat and see if this quarter was simply a fluke, and to eye management's plans to strengthen existing stores. However, even with a 5% drop, it's definitely not the right time to buy additional shares.

With both of these stocks trading near 52-week highs, and DSW trading at nearly 30 times earnings, it's not a good time to buy. I worry about businesses like this; they don't make their own product, and are constantly at risk of margin pressures from competitors (both from each other, e-tail, etc.) due to discounting. The onus is on these companies to provide wonderful customer service, more than ever, for these reasons. Yet, with 14% earnings growth, DSW is doing enough right to warrant a "hold."

So I suggest holding on to your shares, and keeping a critical eye on DSW going forward. They'll need to prove to you that they can weather these margin pressures, and turn their same-store sales around.

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The article DSW Inc. Sank 5% on Earnings... What's Next for the Stock? originally appeared on Fool.com.

Fool contributor Adem Tahiri has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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