(FORTUNE Magazine) – I am sticking my pinkie finger through a stranger's ear. Not through the part that allows you to hear, but through the fleshy lobe. It is pierced. The hole where you would normally insert an earring post has been stretched to about three-fourths of an inch in diameter. It is being held open by a surgical steel "plug."

In a development bound to send chills down the spines of parents everywhere, earlobe stretching, I have just learned, is a popular trend among rebellious teen-agers who have tired of tattoos and body piercing and are moving into other body-modification rituals. (A quick how-to: You pierce the ear the regular way, then insert progressively larger plugs or a taper to stretch the ear until the hole is the size you prefer. If you toss the plugs, cartilage eventually fills in the holes. Supposedly.)

The earlobe is owned by Tamera Brown, who looks like a teenager but is actually a 36-year-old assistant buyer for Hot Topic, a fast-growing clothing chain based in City of Industry, Calif. Her employer has spent the past 14 years following the pulse of the alternative teen demographic more closely than most any other big company. For years, angst-ridden teens sought their edgy wares in small independent stores on Eighth Street in New York City's Greenwich Village, Melrose Avenue in Los Angeles, or Belmont Avenue in Chicago, urban hotbeds of pseudo-subversive underground culture. Hot Topic has taken that antiestablishment vibe and put it in, of all places, the suburban mall.

Hot Topic's tagline, "Everything about the music," reflects its hugely successful operating premise: Music is the primary influence on teen fashion. (Lobe stretchers include Incubus lead singer Brandon Boyd and members of the band Blink 182.) Rock, pop-punk, emo, acid rap, rave, rockabilly--whatever your teen is into, Hot Topic has it. The company's bread and butter is T-shirts featuring bands you've probably never heard of. So whether your teenagers prefer Insane Clown Posse, West Coast Choppers, Good Charlotte, or AFI, they're set. Nipple rings, ghoulish white makeup, or long, vinyl Matrix-like coats to complete the look? Hot Topic's got those, too. What about toys? Kitsch from the 1980s is currently big among teens; so Hot Topic peddles Care Bears and Teenage Mutant Ninja Turtles right next to the red-vinyl miniskirts.

As Addams Family-like as most of the merchandise may sound, there's nothing funky about the business. Founded in 1989 by Orv Madden--a tattooed, Harley-riding former buyer for Federated Department Stores who retired as CEO two years ago--Hot Topic now has 494 stores in malls in 49 states and Puerto Rico. Sales for the company, which FORTUNE has named one of the 100 fastest-growing in the U.S. for the past four years, hit $116 million during the most recent fiscal quarter, up 25% from the year before. Earnings have grown 37% annually over the past five years, according to Thomson Financial/Baseline; this year analysts expect the company to earn $43 million on $546 million in sales. The stock has doubled during the past 12 months. And same-store sales rose 5.2% over the quarter ended in July, much higher than the industry average of 3.3%. The company's challenge: to keep up that growth without losing its alternative mystique.

Hot Topic is a model for other companies seeking to snap up the growing numbers of teens and preteens--the so-called Generation Y and Millennials. Americans ages 13 to 17, who are expected to number some 30 million by 2005, up from 28 million today, spent $20.9 billion on apparel for the year ended July 31, according to market researcher NPD Group. Today's adolescents have much more of their own money than they used to, and parents spend more on them than previous generations did.

Yet enthralling this group is far from easy. Traffic at malls, typically teen hangouts, is down. And other mall names that cater to teens, such as the more mainstream American Eagle and Abercrombie & Fitch, have been plagued with sluggish same-store sales, declining profit margins, and pricing pressure from off-the-mall threats like Wal-Mart and Kohl's that sell similar jeans and khakis at a deep discount. "There are too many retailers playing in the same sandbox," says Hot Topic CEO Betsy McLaughlin, a personable 41-year-old with orange streaks in her hair. She joined the company as vice president of store operations in 1993 after stints at the defunct department-store chain Broadway Stores and trendy casual clothier Millers Outpost.

There's little chance of Wal-Mart's selling a Mars Volta rock tee, a black thong panty emblazoned with a white skull and crossbones, or a seven-inch Bleeding Edge Goths action figure. Because Hot Topic does, it is largely insulated from mainstream competition. Says Autumn Ruiz, a black-clad 12-year-old who was recently trolling the merchandise at a store in Long Island's Roosevelt Field mall: "I just can't get enough of this place."

To stay ahead of the pack, "we react quickly to trends but don't try to predict them," says McLaughlin. Hot Topic's most potent weapon is its own people. "We're all into the music. We all actually live the lifestyle," says Melodi Ramquist, the 35-year-old buyer for Hot Topic's jewelry, cosmetics, gifts, and novelties. (She has face-framing canary-yellow hair, multiple piercings, and a detailed tattoo of Jack and Sally from the Tim Burton film Nightmare Before Christmas on her right upper arm.) "We're very street up, not design down."

That means all Hot Topic staffers, from the CEO to the lowliest store employee, regularly attend concerts by up-and-coming and established bands to scout who's wearing what. The company reimburses store clerks for concert tickets if they write up a fashion report afterward. Such outings are the way Hot Topic picked up on trends like Faygo soda. This year employees noticed the feverish response to Insane Clown Posse band members spraying liter after liter of Faygo--a cheap pop from their hometown of Detroit--on concertgoers. Three weeks later Hot Topic had one-liter bottles of Faygo soda in its stores for $1.99. That's twice what it sells for in Detroit. But for a rabid ICP fan in, say, suburban Iowa, it's worth it. The company sold 35% of its initial 5,200-bottle order in the first week. More than 45,000 bottles have sold since mid-June.

"I've always loved music--all kinds of music," says McLaughlin, who this year has seen concerts by Evanescence, Linkin Park, Mary J. Blige, Hot Wire, and Social Distortion, among others. "But more important, I respect music." It shows. Enter Hot Topic's corporate offices about 40 minutes away from the glam of Los Angeles, and you are greeted by gargoyles--lots of them--and a 27-foot Gothic revival altar that formerly served as a bar in the Las Vegas Hard Rock Cafe. It has been retooled to incorporate several video monitors, all playing music channels MTV, MTV2, or Fuse. The receptionist sits behind a desk that happens to be an antique autopsy table from the 1920s. Walk past the 24-foot red-velvet drapes to get to the open-air main office space, and you'll find more video screens hanging from the rafters. There's even a Family Room, complete with a stage for local and hot-selling bands. Last month pop-punk All-American Rejects performed for the staff.

For wannabe hipsters with antiestablishment attitudes, once it's in, it's out. So when Hot Topic spots a trend, it moves fast. It buys a small quantity of the item from a domestic supplier, then tests it in a handful of stores. If it sells, the chain rolls it out nationwide. That process takes only about six to eight weeks, says McLaughlin. Rock T-shirts can be in the store in two weeks. Using mostly domestic vendors helps maintain that speed. At other retailers, who mainly produce goods overseas, the journey from idea to product can take six to nine months.

Another successful strategy: locking in four-to six-month exclusive agreements with licensed distributors on certain items like T-shirts and accessories. Before The Osbournes or SpongeBob SquarePants became mainstream hits, Hot Topic had exclusive rights to sell their tees, panties, and lunchboxes. By the time the license expired and the Targets and Wal-Marts got in, Hot Topic had moved on to the next thing.

The company often approaches a hot young band, even tracking them down on the road, to see if they're interested in selling their T-shirts at Hot Topic stores. Buyers target bands with a strong local following that haven't hit the big time yet. Mana, a Spanish-speaking underground rock band from Guadalajara, Mexico, with an intense fan base in Southern California and Arizona, is one of them. Hot Topic's got its T-shirts. These days, the royalties a band earns from a T-shirt--typically about 20% of the wholesale price--are about twice those from a CD. Hot Topic tries to help them see the light. "Some bands just get it," says Dan Heitkemper, the company's rock T-shirt buyer and a self-proclaimed teenager trapped in a 34-year-old's body. "Insane Clown Posse gets it. They're like the new KISS, which is one of the greatest merchandising bands in history."

Listening to customers is crucial too. Store managers keep comment cards near the till for shoppers to fill out. Hot Topic's website, through which it makes about 3% of its sales, also solicits e-mailed suggestions. McLaughlin reads more than 1,000 customer comment cards and e-mails a month. Customer suggestions were responsible for Torrid, a fast-growing Hot Topic spinoff that debuted two years ago. Torrid offers the same kind of merchandise Hot Topic does, but in plus sizes for girls and women ages 15 to 29. There are 48 Torrid stores today; McLaughlin says four new ones will open by January.

Here's what else Hot Topic does right. Its stores are small--typically 1,800 square feet, compared to at least 3,500 square feet for the average mall retailer--which keeps overhead costs low. (Hot Topic's average sales per square foot are $619, compared with $367 at the average youth-oriented retailer, according to a survey by Wachovia Securities.) It offers lots of variety--20 different product categories, from toys to tees--meaning there's no risky overexposure to, say, dresses or bottoms that may not sell. It saves millions by not advertising, a move it can get away with because it has no real competitors. And since it sells so few clunkers, it never marks down more than 10% of its merchandise, compared to an industry average of 40%. That keeps margins high: Hot Topic's operating margins were 12.3% last year, compared to 9% or 10% for other teen retailers.

McLaughlin thinks there's still plenty of room to expand. Though the company won't give growth projections for 2004 and beyond, she says that the company has identified at least 300 more malls in the U.S. that meet its demographic criteria. Isn't she worried that if Hot Topic gets too large, teens might cease thinking of it as a voice of the counterculture and start thinking of it as the establishment? Not really, the CEO says: "We go to great pains to not be seen as 'corporate.'"

Still, Hot Topic has its limits. For example, it won't sell T-shirts emblazoned with curse words, with racist or sexist messages, or with anything that promotes alcohol or drug use. When you've got shareholders to answer to, after all, you can't push it too far. "That's why kids will still always come into the city" to shop, contends Rachel Pinker, a manager at Freaks and 8th Street Lab, two independent teenwear stores in New York. Charlotte Brody, a 15-year-old from Chappaqua, N.Y., with pink-streaked hair, says she doesn't shop at Hot Topic as often as she used to: "The people in that store are just trying too hard."

One thing McLaughlin does worry about is a large-scale threat. Sure, Hot Topic has no major competitors now. But is its formula really that hard to duplicate? "It's our biggest fear every day," she says. "But if we're supportive of our customers, surround ourselves with team members who have a shared passion for music, and inspire a workplace that celebrates creativity, uniqueness, diversity, and development, we will fortify our competitive barrier."

Keeping those cool earlobe plugs coming wouldn't hurt, either.

FEEDBACK kallers@fortunemail.com