Why Now Might Be a Great Time to Buy That Diamond Stock

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Over the last few years, companies that traditionally targeted the 1% have branched out. It makes a lot of sense, since the 1% is, by definition, a small group. Companies like Michael Kors (NYSE: KORS  ) and Tiffany (NYSE: TIF  ) have added smaller, less expensive -- but never "cheaper" -- products to their lineups. That small shift has resulted in a new luxury boomtown, with Tiffany stock up 43% over the last 12 months, while Kors has risen 62%.

With the rapid rise, some analysts have started looking for a drop, arguing that the growth has to slow as China pulls back on its own growth. There's no denying that the connection between Asian growth and luxury growth is close, but even domestic companies are seeing great growth. So should investors be worried, or is it time to double down on the high-end?

International growth and American hope
The growth of the Chinese middle class has resulted in a boom for Western companies. On most earnings calls these days, there's a heavy focus on expansion in China, Japan, and Korea. Last quarter, Tiffany opened another new location in China, and it now operates 66 stores in the region. Four more locations are coming this year, with Tiffany hoping that it can continue at the quick growth pace that it's already set in the region. Last quarter, comparable sales rose 9% in its Asia-Pacific region.

The focus on China was well explained in an article by The New Yorker's Evan Osnos earlier this year. In summary, the growth of the Chinese middle class is not just economically driven -- it's ideological. Official documents have called the middle class, "the force necessary to eliminate privilege and curb poverty."

At home, the growth of luxury goods has similar roots. The American middle class is slowly escaping the financial crisis -- or simply tiring of its household austerity -- and that's driving more aspirational purchasing. Kors has seen growth in its small leather goods product line, which is a lower entry point into the brand. The expansion of middle-class spending with the ever-increasing reach of the American upper class is combining to drive up profits at domestic retailers, as well.

The 1% has seen phenomenal income growth recently, and that's spurred growth at companies like Saks (UNKNOWN: SKS.DL2  ) and Nordstom (NYSE: JWN  ) , both of which managed 5% increases in revenue in the last quarter.

Where luxury goes next
The thesis for investing in any one of these companies has to be broader than just "luxury is doing well." For Nordstrom, it's about the customer experience. For Kors, it's the rise of the brand. At Saks, you might be interested in the rumored buyout. A Tiffany investment might hinge on a turnaround in the brand value. However, no matter what that specific thesis looks like, it needs to be underpinned by a belief in luxury's growth potential.

There's one big thing that makes me worry about investing in luxury stocks, right now -- the slowdown in China. Not only does it bode ill for companies focusing on China, it's going to have knock-on effects for domestic businesses. Spending by Chinese tourists overseas is third only to Americans and Germans. That spending is helping companies out, even if they have no locations in China, and a slowdown in the economy is going to slow that pipeline.

The reason to be hopeful about luxury stocks is that the American recovery is still unfolding. While the current crush may already seem unbearably long, the country is full of upside. That's a longer-term view than some investors are happy with, though, and with the current quagmire in the federal government, investing in a positive outcome may seem like a bridge too far.

Regardless of your long-term view, you should check out The Motley Fool's special report on Michael Kors. It's one of today's hottest high-end fashion brands, and that's translated into one of the best-performing stocks in retail -- since its debut on the market in late 2011, the share price has more than doubled. But with all that growth, has the stock finally become too expensive, or is there still room left to run? The Motley Fool's premium report on Michael Kors gives investors all the information they need to make the right decision. We cover the key must-watch areas, opportunities, and threats to the company that investors need to know. To claim your copy, simply click here now for instant access.

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Related Tickers

9/27/2016 4:02 PM
JWN $51.71 Up +0.21 +0.41%
Nordstrom CAPS Rating: ****
KORS $48.17 Up +0.20 +0.42%
Michael Kors Holdi… CAPS Rating: ****
SKS.DL2 $0.00 Down +0.00 +0.00%
Saks, Inc. CAPS Rating: *
TIF $71.65 Up +0.30 +0.42%
Tiffany and Co. CAPS Rating: **