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Is Coach, Inc. (COH)’s Stock Destined for Greatness?

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Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Coach, Inc. (NYSE:COH) fit the bill? Let’s look at what its recent results tell us about its potential for future gains.

Coach, Inc. (NYSE:COH)

What we’re looking for

The graphs you’re about to see tell Coach, Inc. (NYSE:COH)’s story, and we’ll be grading the quality of that story in several ways:

1). Growth: are profits, margins, and free cash flow all increasing?
2). Valuation
: is share price growing in line with earnings per share?
3). Opportunities
: is return on equity increasing while debt to equity declines?
4). Dividends
: are dividends consistently growing in a sustainable way?

What the numbers tell you

Now, let’s take a look at Coach, Inc. (NYSE:COH)’s key statistics:

COH Total Return Price Chart

COH Total Return Price data by YCharts

Passing Criteria 3-Year* Change Grade
Revenue growth > 30% 45.8% Pass
Improving profit margin 6.1% Pass
Free cash flow growth > Net income growth 8.7% vs. 55.4% Fail
Improving EPS 73% Pass
Stock growth (+ 15%) < EPS growth 54% vs. 73% Pass

Source: YCharts.
*Period begins at end of Q1 2010.

COH Return on Equity Chart

COH Return on Equity data by YCharts

Passing Criteria 3-Year* Change Grade
Improving return on equity 30.4% Pass
Declining debt to equity (32.7%) Pass
Dividend growth > 25% 125% Pass
Free cash flow payout ratio < 50% 37.1% Pass

Source: YCharts.
*Period begins at end of Q1 2010.

How we got here and where we’re going

Coach, Inc. (NYSE:COH) passes all but one of these tests with flying colors, missing out on a perfect score only because free cash flow wasn’t quite kept pace with net income growth. However, it’s worth noting that both metrics have been neck and neck in terms of raw results since 2011, and Coach has a solid chance of earning a passing grade on this test when we examine it again next year. However, will this solid progress continue through next year? Let’s dig a little deeper.

Luxury retail may not be a zero-sum game, but many fashionistas will only have room in their closets (or on their credit cards) for one go-to brand. That’s been Coach, Inc. (NYSE:COH)’s peril over the last year or so as Michael Kors Holdings Ltd (NYSE:KORS) continues to gain mind and market share in the high-end segment. Michael Kors Holdings Ltd (NYSE:KORS) hasn’t been around for very long, but its public results are trouncing Coach’s so far — the former has more than doubled its trailing 12-month net income, which is itself more than double its rate of revenue growth, compared to Coach’s 12% year-over-year growth since the start of 2012. Coach needs a certain degree of cachet to justify continued growth as a “status” retailer, and as my fellow Fool Demitrios Kalogeropoulos points out, the company has been focusing on growth in its lower-cost segments, which not only keeps margins down, it also has the effect of diminishing its formerly high-end sheen even as Kors encroaches on that slice of the market.

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