Do you have the temperment to go against the crowd?
It is easy to say... but harder to do.
Leather goods designer/manufacturer Coach (COH) reported lower than year ago, but better than analysts' expectation, fiscal third quarter EPS. The shares cratered pre-market and never really rebounded, closing the day down by 9.34%, at $45.71.
Media coverage went overboard detailing all the reasons why the decline was justified. Talking heads made it perfectly clear why nobody should be interested in owning this iconic luxury goods name, even at a historically ultra-cheap valuation.
Fiscal 2014 (ends June 28, 2014) will mark only the second time, since its 1985 spin-off from Sara Lee, that COH earns less than it did the year before. When was the other time that happened? In fiscal 2009 when earnings declined from $2.08 to $1.91. Coach shares plunged from $37.59 at 2008’s peak to just $11.40 near the market bottom in early 2009.
People avoided the stock at a ridiculously low P/E. They were sure The Great Recession would be the death knell for retailers. The funeral had to be called off, though, after EPS bounced back by almost 22% the next year to what was then an all-time high of $2.33. Before the year was over COH shares had spiked by 228%.
You don’t get many chances to buy shares at rock-bottom prices. When you can, there are always valid reasons why the stock is out of favor and not expected to recover. Smart investors learn to hold their noses and buy anyway.
How does Coach stack up now, compared with some of its best buying opportunities since 2009? Brilliantly, even when taking into account the lowered estimates for this year and next.
The company’s P/E now sits at just 13.5x fiscal 2015’s projection. COH’s current yield of 2.93% is the highest ever paid by this venerable firm. Just as in 2009, nobody is willing to step up and publicly defend a name drawing so much bad press.
Every share that was dumped in despair today, with much fanfare, was being quietly accumulated by value seekers. History says that will work out well for those brave contrarians.
The last three occasions when COH was available near this valuation all proved to be outstanding trading opportunities. The low of $33 in 2010 was followed by $58.60 intra-year. The summer 2011 bottom of $45.70 preceded a move to $79.70 over the next eight months. The early 2013 price of $45.90 offered a quick 35% pop in less than five months.
Numbers crunchers at research firm Morningstar rated Coach as a 4-star BUY going in to today's quarterly report. They saw fair value as $60. That leaves some nice upside following Tuesday’s sell-off. Don’t forget, actual profits of 68 cents per share handily exceeded analyst estimates. Foreign sales were good; it was only domestic same store sales that disappointed.
Management gets paid big bucks to remedy situations like that.
There is no reason to believe that Coach won’t earn $3.40 or so next year. Apply a modest 16 multiple to that number and you get a price 19% above the present quote. Add in dividends and 22% in total return becomes a conservative goal over the next 12 to 15 months.
Intrigued, but wary of whether we’ve seen the near-term bottom? Consider selling some January 2016, $45 puts at $6.70 per share. You will either get exercised at a net cost of $38.30 ($45 strike price: $6.70 put premium) or keep $670 per contract without buying any shares.
Nobody can guarantee that Coach won’t retreat to below that break-even level. What I can say for sure is that not one share of Coach has changed hands for that little in almost four years.
For patient investors, Coach should provide a first-class return on investment.
Disclosure: Long COH shares, short COH options
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