Streetwise for Sunday August 17, 2008

Streetwise

Lauren Rudd

Sunday, August 17, 2008

Do Not Let An Erratic Market Scare You

Few will disagree that the performance of the equity markets has been erratic, unpredictable and just plain not fun. Daily fluctuations of 100 or more points, often into negative territory by the Dow Jones industrial average are all too common.

Furthermore, there is no shortage of prognosticators willing to tell anyone who will listen (the media generally tune them in with rapt attention) just how much worse the future is likely to be. If all that negativism has you wondering if Wall Street is the street you should be on, maybe the following will help shine a bit of realistic light into that dark abyss we call the future.

Begin by looking back in history to the 1970s. Investing back then was a courageous feat when you consider that the Dow fell from 1,072 in 1973 to a low of 578 in December of 1974. That makes this bear market look sort of puny.

So, do I believe we will see a revival of what many are quick to refer to as a dead market? Since I am running out of fetching ways to answer that question, let me simply say that the answer is yes.

The stock market has retrenched before and it will do so again. In fact, it will retrench periodically. In between each of those retrenchments there will be an upward cycle that will take the markets to new highs. Simply put, that is how Wall Street operates.

The key reason is that the financial markets are tied in a myriad of ways to both corporate profits and the economy, and neither of those entities will continue upward in an uninterrupted manner. Rather they rise and fall and the cycle length is undeterminable. You can develop as sophisticated a model as you want but that is the essence of it all.

So what do you do at this point in time? Again, the answer is an easy one. You use the retrenchment to invest in stocks that you believe have the greatest potential to generate gains during the next upturn. Furthermore, if you select carefully you will likely enjoy lesser but reasonable gains even in the current environment.

Do you need an example? I thought so. You might want to consider Coach (COH), a company that has been discussed here at least twice before and one that appears at this time to be considerably under priced.

Coach designs and manufactures high-end leather goods and accessories, mostly for women. Because of the upscale positioning of its products and a seemingly dedicated clientele, the chain is somewhat recession proof.

However, bottom line performance is really all that counts in the investment world and Coach delivers. The company recently announced that its fourth quarter sales increased 20 percent over the prior year, coming in at $782 million. Net income for the quarter also rose almost 20 percent to $0.50 per share, compared with $0.42 per share a year ago.

For the full fiscal year, earnings per share increased to $2.06 per share, up 22 percent from a year ago, excluding a one-time gain of $0.11 for the year. My earnings estimate a year ago was for $2.10 per share.

Net sales for the year were $3.18 billion, up 22 percent from a year ago. If you exclude currency effects, the increase in sales was 20 percent. The company also posted a return on invested capital for the year of about 41 percent. Coach’s stated guidance for fiscal 2009 is for sales of about $3.61 billion and $2.25 per share in earnings. The management considers the guidance to be minimum performance.

The intrinsic value of the shares using a discounted earnings model, with an earnings growth rate of 10 percent and an 11 percent discount rate, is $59 per share. The more conservative free cash flow to the firm model produces an intrinsic value of $48 per share. The shares recently traded at about $30.69.