How Coach Stacks Up

I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer, too. But even I have to admit some growth stories are bogus, hence this regular series.

Next up: Coach (NYSE: COH). Is this maker of designer handbags and other women's accessories the real thing? Let's get right to the numbers.

Foolish facts

Data current as of Nov. 22.

Fools like Coach, mostly. But they don't love the stock, and they haven't for a while. The company last earned a four-star CAPS rating in May 2009. Those who remain bullish on the handbag maker's prospects believe in CEO Lew Frankfort's strategy.

"Coach is a smart company ... They have no debt, a lot of cash, and they are in tune with their customer-base like few are. Sales have benefited from higher-end consumers buying less pricey purses, and middle-end consumers buying Coach's affordable, yet fashionable product. As the rebound continues, I foresee Coach continuing to do well because, well, they know how to do well," wrote All-Star investor NathanExplosion earlier this month.

I agree, if only because I got to see this same dynamic at work while shopping with my wife over the weekend. The outlet store we visited was not only packed tight, like sardines in a can, but shoppers were of every stripe. Coach has broader appeal than many of its luxury peers.

But don't take my word for it; check out the company's fiscal first-quarter earnings report. Net income increased 34% on a 20% increase in sales. A lot of that growth was organic. Same-store sales rose 8.5% in the U.S. and by double-digits in China. Gross margin expanded nearly 2 percentage points.

The elements of growth

Source: Capital IQ, a division of Standard & Poor's.

Looking at this table, I'm surprised anyone harbors doubts about Coach. Let's review:

• Both revenue and normalized net income growth are accelerating, exactly what we want to see in a growth stock.
• Expanding gross margin is also an excellent sign. It suggests that Coach continues to demonstrate pricing power even as it diversifies its customer base. Clearly, Frankfort's strategy is working.
• If there's an issue with Coach, it's that receivables have outgrown revenue in two of the past three years. Inventory is growing even faster.
• Finally, investors have to love how shares outstanding have declined as the stock has soared. Not that I'm surprised. With returns on capital trending at or above 40% for years, management's investing prowess is well established.

Competitor and peer checkup

Source: Capital IQ, a division of Standard & Poor's. Data current as of Nov. 22.

On the basis of normalized net income, Coach is nowhere near the best growth story in this table. That honor goes to Fossil and CEO Kosta Kartsotis, who made a fortune buying shares of his company during a turnaround. (Crow, meet mouth.)

Grade: Sustainable
And yet, I'm not sure it matters. Coach has produced more free cash flow than net income in recent years. Plus, with margins expanding and store traffic soaring, this growth story appear to have many chapters left. That's why I've rated the stock to outperform in my CAPS portfolio.

Now it's your turn to weigh in. Do you like Coach at these levels? Let us know what you think using the comments box below. You can also ask Tim to evaluate a favorite growth story by sending him an email, or replying to him on Twitter.

Interested in more info on Coach? Add it to your watchlist by clicking here.