Three Reasons to Buy this Luxury Stock

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

A luxury brand is one of the most valuable assets a company can have. Premium brands command higher prices and better profit margins, and they protect the company from the competition via product differentiation. Even as the luxury business can be volatile, depending on the business cycle these kinds of companies have the possibility to reward shareholders with superior returns over long periods of time.

Looking among different alternatives in the business, Coach (NYSE: COH) stands out as a company with higher profitability and a cheaper valuation, and the business has some very exciting growth opportunities coming from expansion in China and new product introduction. Three powerful reasons to consider a long position in this high quality company:

1. A Very Luxurious Brand

Not every expensive or luxurious brand means a competitive advantage; the company needs to be able to generate higher profitability from that brand in order to consider it a differentiating asset. From that perspective, Coach is as luxurious as they come.

The following table compares profitability measures for Coach versus other high end brands like Michael Kors (NYSE: KORS), Tiffany (NYSE: TIF), Lululemon (NASDAQ: LULU) and Polo Ralph Lauren (NYSE: RL). Coach comes out like a clear winner in terms of the three rations compared: return on equity, gross margins and operating margins.

<img src="/media/images/user_1532/profitability_large.jpg" />

2. An Attractive Valuation

In spite of this superior profitability, Coach is the cheapest company in the group in terms of P/E ratio, both on a trailing and forward looking basis.

<img src="/media/images/user_1532/coh-valuation_large.jpg" />
 

From a historical perspective, this P/E ratio in the area of 16 is quite low, except during the financial crisis, the company has usually traded at higher valuations. The dividend yield is also at maximums due to a combination of rising dividends and lackluster price action over the last year.

<img src="/media/images/user_1532/coh-pe_1_large.jpg" />

<img src="/media/images/user_1532/dividends_1_large.jpg" />

 

3.  The Future Looks Good

Coach is betting heavily on China for growth, management plans to increase sales in the country to $500 million in 2014 from $300 million expected in 2012. The slowing Chinese economy may have something to do with investors' negativity regarding the company, but the naysayers may be missing the big picture here.

To begin with, China is on track to achieve GDP growth in the area of 7.5% this year, this may be quite slower than past rates above 9%, but still an enviable growth rate in comparison to most other nations in the world, emerging or developed. Over the long term, the Chinese middle class will keep expanding at an amazing speed, and Coach is in a great position to benefit from that powerful economic trend.

Just to keep things in perspective, Coach reported a 40% increase in China sales for the last quarter, supported by double digit growth in same-store sales. I'll take that slowdown anytime.

Besides, the company is expanding into new products, like broadening its shoes offerings and introducing a line of products for men. This is a smart way to leverage the brand power, especially in China and other Asian countries where men are more prone to high end accessories.

Being a Smart Shopper

You don't usually find high-quality products from distinguished brands at big discounts on the stores, and when you do, you know that's an opportunity. The same criteria should maybe be applied to investing, and shares of Coach look like a great chance to acquire an outstanding company at an unusually low valuation.

 


acardenal owns shares of Coach. The Motley Fool owns shares of Coach, Lululemon Athletica, and Tiffany & Co. Motley Fool newsletter services recommend Coach and Lululemon Athletica. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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