Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Coach, Inc. (NYSE:COH) fit the bill? Let’s look at what its recent results tell us about its potential for future gains.
What we’re looking for
The graphs you’re about to see tell Coach, Inc. (NYSE:COH)’s story, and we’ll be grading the quality of that story in several ways:
1). Growth: are profits, margins, and free cash flow all increasing?
2). Valuation: is share price growing in line with earnings per share?
3). Opportunities: is return on equity increasing while debt to equity declines?
4). Dividends: are dividends consistently growing in a sustainable way?
What the numbers tell you
Now, let’s take a look at Coach, Inc. (NYSE:COH)’s key statistics:
COH Total Return Price data by YCharts
| Passing Criteria | 3-Year* Change | Grade |
|---|---|---|
| Revenue growth > 30% | 45.8% | Pass |
| Improving profit margin | 6.1% | Pass |
| Free cash flow growth > Net income growth | 8.7% vs. 55.4% | Fail |
| Improving EPS | 73% | Pass |
| Stock growth (+ 15%) < EPS growth | 54% vs. 73% | Pass |
Source: YCharts.
*Period begins at end of Q1 2010.
COH Return on Equity data by YCharts
| Passing Criteria | 3-Year* Change | Grade |
|---|---|---|
| Improving return on equity | 30.4% | Pass |
| Declining debt to equity | (32.7%) | Pass |
| Dividend growth > 25% | 125% | Pass |
| Free cash flow payout ratio < 50% | 37.1% | Pass |
Source: YCharts.
*Period begins at end of Q1 2010.
How we got here and where we’re going
Coach, Inc. (NYSE:COH) passes all but one of these tests with flying colors, missing out on a perfect score only because free cash flow wasn’t quite kept pace with net income growth. However, it’s worth noting that both metrics have been neck and neck in terms of raw results since 2011, and Coach has a solid chance of earning a passing grade on this test when we examine it again next year. However, will this solid progress continue through next year? Let’s dig a little deeper.
Luxury retail may not be a zero-sum game, but many fashionistas will only have room in their closets (or on their credit cards) for one go-to brand. That’s been Coach, Inc. (NYSE:COH)’s peril over the last year or so as Michael Kors Holdings Ltd (NYSE:KORS) continues to gain mind and market share in the high-end segment. Michael Kors Holdings Ltd (NYSE:KORS) hasn’t been around for very long, but its public results are trouncing Coach’s so far — the former has more than doubled its trailing 12-month net income, which is itself more than double its rate of revenue growth, compared to Coach’s 12% year-over-year growth since the start of 2012. Coach needs a certain degree of cachet to justify continued growth as a “status” retailer, and as my fellow Fool Demitrios Kalogeropoulos points out, the company has been focusing on growth in its lower-cost segments, which not only keeps margins down, it also has the effect of diminishing its formerly high-end sheen even as Kors encroaches on that slice of the market.
The strange thing is that an ostensibly luxury brand has become a solid value stock, with low valuations and a solid but sustainable dividend that has grown rapidly in recent years. That’s one advantage Kors can’t match, but it’s only one part of the puzzle necessary for long-term gains. The market’s perception at the moment is that Coach is falling behind in fashion, which could be rewarding to long-term shareholders if consumer perceptions wind up being different. However, it’s also worth noting that fashions don’t become fashionable again immediately — real changes need to be made to Coach’s style to keep it at the forefront of public interest. That might happen sooner rather than later, as the company recently decided to let one of its top designers walk when his contract expires next year.
Putting the pieces together
Today, Coach has many of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy — or to stay away from a stock that’s going nowhere.
The article Is Coach’s Stock Destined for Greatness? originally appeared on Fool.com and is written by Alex Planes.
Fool contributor Alex Planes holds no financial position in any company mentioned here. Add him on Google+ or follow him on Twitter, @TMFBiggles, for more insight into markets, history, and technology.The Motley Fool recommends and owns shares of Coach.
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