In July 2012, we initiated positions in Coach (COH
) as we are convinced that the Company managed to solidify its competitive edge, evidenced by the fact that they have maintained a return on invested capital far superior to its competitive peer group of publicly traded suppliers, rivals & substitutes. The Company’s competitive edge has been strengthened over the past decade as Coach has maintained rigorous contact with consumers, interviewing tens of thousands per year. Of course, this helps with short-term fashion trends, but more importantly and more sustainably, we think this helped Coach understand that luxury consumers were less interested in exclusivity related to physical shortages of a product and more interested in exclusivity related to “virtual rarity” – or the abstract feelings of privilege and of exclusivity. Elements like country of origin and even the quality of materials have been deemphasized in favor of accessibility.1 As a result, Coach now manufactures about 75% of its products in China, which reduces cost of goods relative to European and American made luxury products. Further, Coach sells 90% of its products through direct channels which protects gross margins from the pricing pressures of wholesalers. Prior to the Coach acquisition, the Fund lacked a holding that was focused on retail apparel and accessories, so we think this position adds diversity.
Coach exhibited most of our process factors as early as 2008, but at any one time, our list of potential holdings that exhibit four out of five factors, usually hovers in a range of about 15 to 25 names, with the majority of those names exhibiting an unattractive valuation. But valuation is a very dynamic element and it can change especially rapidly in volatile markets. On the other hand, during market rallies or other periods of market placidity, the valuations of our potential ideas generally maintain their unattractiveness.
From Wedgewood Partners Third Quarter 2012 Review and Outlook