What happened
By all rights, Tiffany & Co. (TIF) stock should be surging.
Yesterday, the jeweler reported 26% earnings growth on sales growth of 12%, and boosted its earnings forecast to boot. On Wall Street, analysts are cheering, with RBC Capital lifting its price target on Tiffany stock from $126 to $132 per share, UBS hiking from $138 to $141, and KeyBanc taking its target from $140 to $150 a share, according to a tally on TheFly.com.
And yet, Tiffany shares dove as much as 5.1% in early trading Wednesday and are still down 4.4% as of 1:10 p.m. EDT.
Why?
Investors thank Tiffany stock for the wonderful earnings report -- and kiss it goodbye. Image source: Getty Images.
So what
We actually covered this story for you last night, but it never hurts to review. In the second quarter of 2018, Tiffany reported strong sales growth of 12% year over year, and a 150 basis-point increase in gross margin that should have cascaded all the way down to the bottom line. And in fact, on the bottom line, Tiffany did show a big increase, with profits rising 26% and net profit margin up 150 basis points.
It's what happened in between gross margin and net margin, however, that's the problem.
Specifically, selling, general, and administration expenses increased 20% -- faster than sales growth and enough to torpedo earnings growth, but for the fact that Tiffany enjoyed beaucoup benefits from President Trump's tax reform project of last year. One could even argue that essentially all of Tiffany's earnings growth during the quarter came from tax reform, and not from Tiffany itself.
Now what
So what does this mean for Tiffany stock? According to management, Tiffany will build on Q2's success and grow its earnings to between $4.65 and $4.80 per diluted share by year-end.
Relative to the $2.96 per share that Tiffany earned last year, that could work out to about 59% earnings growth for the year. At the same time, however, Tiffany is carrying a very high P/E ratio of 35.6 times earnings right now. This wouldn't be a problem if Tiffany were expected to maintain a 59% earnings growth rate. But tax reform was a one-time event. We can't expect it to be repeated and to continue boosting earnings in future years.
Indeed, most analysts think Tiffany will be lucky to eke out even 12% earnings growth over the next five years. That's not a very fast growth rate to support Tiffany's sky-high P/E ratio. My hunch is that investors are right to cash in on this week's earnings success -- and cash out of Tiffany stock.
