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Luxury Retailer's Comeback Could Return Double-Digit Profits

Jim Woods

One of the things I've learned over the years is that when people have a lot of money, they tend to spend it on things that tell the world they're successful. We can see this by looking at the way early cultures opulently adorned their kings, queens and tribal leaders. Fast-forward to the present day, and we see that the consumption of luxury goods by the "haves" still flourishes.

For investors, that means there's going to be opportunities to capitalize on the luxury trade.

The latest example of luxury trade profits is upscale leather handbag and accessories maker Coach (COH). The stock spiked 10% Tuesday after the company reported fiscal third-quarter results that included a huge jump in sales in one of its biggest markets, China. In fact, Coach said sales in the second-largest economy in the world grew an amazing 40% from the same quarter a year ago.

Coach Stock Chart

The move higher represents a reversal of fortune for investors. Excluding Tuesday's spike, the stock had taken a big hit in 2013, falling more than 18% since mid-January. The catalyst for this year's sell-off came when the company reported disappointing fiscal Q2 numbers. This ignited a selling frenzy that took COH below its short-term, 50-day moving average, as well as its long-term, 200-day moving average.

In the days and weeks following the Q2 earnings announcement, many Wall Street analysts moved to distance themselves from the stock. For example, Zacks reduced their rating on the shares to a "strong sell" after the news, citing tough macroeconomic conditions and intense competition from rivals. Well, that call doesn't appear to be too prescient given this week's results.

Now, while Coach did have a tough holiday season, and while market share has been taken away by the likes of rival Michael Kors (KORS), the brand hasn't lost its mojo -- especially in status-conscious China. Evidence of that can be seen in the company's Q3 metrics.

Coach said Q3 net income jumped 6% to $239 million, up from $225 million during the same quarter the prior year. Earnings per share (EPS) came in at $0.84, above the consensus forecast for EPS of $0.80. And Q3 revenue of $1.19 billion was up 7% from the prior year. To top off the bullish quarter, Coach announced that it was increasing its annual dividend by 12.5% to $1.35 a share from $1.20 previously.

The strong Q3 numbers for Coach, and the response from traders, shows that the luxury trade in this stock is by no means dead. In fact, Tuesday's buying drove COH back above the 200-day moving average, a bullish sign for the shares going forward.

Yet, what is perhaps an even more bullish sign for the stock going forward is the realization that Chinese luxury sales are back, and that is a powerful driver going forward. With millions of class-conscious Chinese demonstrating an appetite for Coach, fiscal Q4 could turn out to be another big winner.

I suspect this stock can climb another 15% before the company's next earnings report, due in July.

Recommended Trade Setup:

-- Buy COH at the market price
-- Set stop-loss at $51.77, approximately 8% below current prices
-- Set initial price target at $64.72 for a potential 15% gain in three months

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