Streetwise

Lauren Rudd

Sunday, August 19, 2012

Vigilance is Mandatory

Despite all the doom and gloom surrounding both the national and global economy, there are always companies that will manage to push ahead despite facing a less than an ideal economic environment. However, I must constrain that statement by once again pointing out the need for adding a stop loss as a backstop order to protect your profits. To see what I mean, consider Coach (COH), one of my favorite retail investment candidates.

When I last talked about the Company a year ago, the shares were selling for $54.78. My 2012 earnings estimate was $3.40 per share and with a 12-month target price on the shares of $63 for an estimated capital gain of 15 percent. So how did the Company perform? Earnings per share rose 21 percent to $3.53 from $2.92, yet the shares recently closed at $54.33. So while earnings came in well beyond my forecast, there was virtually no change in the share price over a 12-month period, right? No, not quite.

Here is where a vigilant stance with regard to your portfolio plays a key role. During the month of March, Coach’s share price had topped $78, well beyond my forecast. However, after Coach released third quarter earnings for the period ended March 31, the price of the shares began to trend downward.

There was no good reason; sales were up 17 percent when compared to the year prior, while earnings increased 24 percent. Nonetheless, the prudent move would have been a sell stop order at about $70. In doing so, You would have sacrificed 10 percent of the run up in share price, while still holding on to a 28 percent capital gain.

So how do you know when to definitively add a stop loss? You estimate what you are willing to return when a stock reaches or exceeds a predetermined price projection, in this case about 10 percent of the $79 share price, and be prepared to sell. After which you watch from the sidelines as you wait for the share price to plateau, albeit at a lower level.

Now comes your second decision point. Do you repurchase the shares if you sold, or purchase the shares either as a new investor or on a dollar-cost averaging basis if you did not sell. The answer is easy to pontificate on but more difficult to implement. Essentially, you need to do a full analysis on the company and determine if the shares still make investment sense.

Coach, famous for its expensive leather hand bags, caters to the wealthier part of society, those that are less prone to feel the effects of an economic downturn. Moreover, Coach is able to maintain its panache because many women regard its products with a near religious fervor. Furthermore, Coach’s sustained focus on sales productivity at the store level, merchandising, marketing and strategic pricing, has helped the Company to not only remain afloat in a difficult consumer environment, but drive comparable-store sales higher as well.

For the fiscal year ended June 30, Coach reported net sales of $4.76 billion, a 15 percent increase over the prior year. Net income increased 18 percent to $1.04 billion from $881 million. In addition, as I mentioned earlier, earnings per share rose 21 percent to $3.53 from $2.92.

During FY12 and FY11 the Company recorded certain one-time items, including favorable tax settlements. In both years the Company made charitable contributions which precisely offset the benefit of those settlements to net income. Therefore, on a GAAP basis, operating income for the fiscal year 2012 was $1.51 billion with a 31.7 percent operating margin and a SG&A expense ratio was 41.0 percent, as compared to operating income of $1.30 billion and an operating margin of 31.4 percent with a SG&A expense ratio of 41.3 percent the prior year.