Has Coach Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Coach (TPR 0.03%) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

• Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
• Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
• Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
• Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
• Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
• Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Coach.

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Coach last year, the company has gained two points, more than making up for the point it lost from 2011 to 2012 as dividend yield grew substantially, and the company's valuation became more favorable. Unfortunately, the valuation improvement came at the expense of current shareholders, who have seen the stock drop more than 30% over the past year.

For years, luxury retailers bucked the recessionary trend, with high-end shoppers having the wealth to sustain their shopping patterns, even in a weak economy. In addition, both Coach and luxury jewelry retailer Tiffany (TIF) benefited greatly from emerging-market growth, as a rising consumer class sought to buy up their high-status products.

But recently, Coach has finally seen tough times catch up with it. In its most recent quarter, Coach fell well short of expectations in terms of both revenue and earnings, and the stock has sold off sharply in response. Competitors Michael Kors (CPRI -0.11%) and Ralph Lauren (RL -1.21%) have fared much better than Coach by pitching themselves as so-called lifestyle brands, allowing them to sell a wider array of products, and taking maximum advantage of the value of their brand names. By contrast, Coach's Legacy handbag line didn't pay off the way the company had hoped, and a strategic shift toward women's apparel and accessories could erode Coach's big margin advantage over Tiffany, Kors, and Ralph Lauren.

One big challenge that Coach will soon face is the departure of CEO Lew Frankfort, who will step down next year. With so much of the company's success having come on Frankfort's watch, Coach will need to demonstrate its ability to keep its customers happy.

For Coach to improve, it needs to focus on finding new avenues for sales growth. If the company can boost revenue, then Coach could hurdle past the remaining obstacles to reach perfection.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

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