Stocks Buffett and Lynch would wear

Despite Burberry's recent profit warning, several luxury goods purveyors look attractive.

By John Reese Sep 12, 2012 12:01PM

Young woman clothes shopping, copyright Image Source, Getty Images When the financial crisis and Great Recession rocked the U.S. and global economies back in 2008, it was supposed to be the death knell for luxury goods companies and their stocks. After all, the U.S. consumer was dying, the pundits said, and who buys thousand-dollar handbags on their death bed?


But the last few years have shown that American consumers, while taking blows, are alive and kicking. Americans have increased their daily spending (not including normal household bills or purchases of cars or homes) by about 30% since early 2009, according to a recent Gallup poll, while government data shows that retail and food service sales have well eclipsed their pre-recession highs. Combine that resiliency with growing middle classes in emerging market nations like China, and luxury goods companies have actually fared pretty well recently.

While Burberry's recent profit warning made headlines, designer bag and scarf designer Hermes International recently said its first-half profit was up 28%; shoe and clothing designer Salvatore Ferragamo's second-quarter net profit rose 22.5%; and handbag and accessory maker Coach, Inc. (COH), recently reported earnings were up 21% and revenues were up about 15% for its 2012 fiscal year (ending June 30).


It was the third straight strong year for Coach, which upped earnings 25% and sales about 15% in FY2011, and earnings 22% and sales 12% in FY2010. The company is one I've paid close attention to, because my Warren Buffett-inspired Guru Strategy snatched up its shares in early September 2009 -- a time when luxury goods stocks were surrounded by fear. Since then, the stock has surged more than 100% as Coach has rebounded.


My Buffett-inspired model is still quite high on New York City-based Coach ($17 billion market cap). The strategy looks for companies with lengthy histories of earnings growth, manageable debt, and high returns on equity (which is a sign of the "durable competitive advantage" Buffett is known to seek). Coach delivers on all fronts. Its earnings per share have dipped in only one year of the past decade; it has just $1 million in long-term debt and more than a $1 billion in annual earnings; and its 10-year average ROE is an impressive 37.0%. Coach's shares are also reasonably priced, trading at an earnings yield of about 5.9%.


The strategy I base on the writings of mutual fund great Peter Lynch is also high on Coach. Lynch famously used the price/earnings-to-growth (PEG) ratio to find bargain stocks, adjusting the "growth" portion of the equation to include yield for dividend payers; yield-adjusted PEGs below 1.0 are acceptable to my Lynch-based model. When we divide Coach's 17 price-to-earnings (P/E) ratio by the sum of its growth rate (17.1%, using an average of the three-, four-, and five-year earnings per share growth rates) and yield (2%), we get a yield-adjusted PEG of 0.89 -- a sign that the stock is a bargain.


Coach isn't the only luxury goods stock my models like right now. Here are a few others that make the grade:


Estee Lauder Companies (EL): Based in New York City, this maker of skin care, makeup, fragrances, and hair care products is another favorite of my Lynch-based model. A big reason is that it has been growing earnings per share (EPS) at a 29.3% rate over the long term. Lauder's shares look pricey, at 28.2 times earnings, but its growth rate makes it worth the higher price tag -- the stock's PEG comes in just under the model's limit, at 0.96. Another reason the Lynch approach likes Lauder: The firm's debt-to-equity ratio is a reasonable 47%.


Fossil, Inc. (FOSL): Fossil, based in Texas, makes a variety of watches, handbags, clothing, and other accessories. Like Coach, the $5.2-billion-market-cap company gets strong interest from both my Buffett- and Lynch-based models. My Buffett approach likes that Fossil's EPS have declined just once in the past decade, and the fact that the company has nearly three times as much annual earnings ($298 million) as long-term debt ($106 million). Fossil also has averaged a 10-year return on equity of 17.1%.


My Lynch-based model, meanwhile, likes Fossil's 30.4% long-term EPS growth rate and 17.8 P/E, which make for a bargain-priced 0.58 PEG ratio. It also likes that the firm's debt-to-equity ratio is a shade under 10%.


Guess? Inc. (GES): This Los Angeles company makes trendy jeans and a variety of other clothing and accessories. My Lynch-based model is high on the $2.3-billion-market-cap company, thanks in part to its 39.2% long-term EPS growth rate and 10.4 P/E, which make for a stellar 0.26 PEG ratio. The Lynch model also likes that Guess's debt-to-equity ratio is a miniscule 0.99%.


Daimler AG (DDAIF): The Germany-based car and truck maker counts one of the ultimate luxury car brands -- Mercedes -- among its products. The $53-billion-market-cap firm has posted strong growth the past couple years even while Europe's economy has languished, and it gets high marks from my James O'Shaughnessy-based value model. When looking for value plays, O'Shaughnessy targeted large firms with strong cash flows and high dividend yields. Daimler is plenty big enough, and has an impressive $11.49 in cash flow per share (more than eight times the market mean). Plus, it has a dividend yield of 5.9%, so it makes the grade.


John Reese is long GES.





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