Growth company highlight: Coach Inc (COH)

Readers of our client letters and our Taylor Frigon blog know that in the past, we have highlighted some examples of businesses which we believe fit the definition of a Taylor Frigon growth company. These short vignettes outline the business model of the company and give a brief overview of our investment thesis for the business. They typically feature a company which we own for the Core Growth Strategy at the time of publication, and enable our clients to gain some insight into the reason we own a particular company and the characteristics of the companies which we believe can be described as “well-run companies positioned in front of fertile fields for future growth.”

Previous companies we have highlighted include EZchip and CH Robinson Worldwide, and while we do invest in many companies that are involved in what we believe are high-growth aspects of the high-tech industry, we often feature companies that are not primarily tech companies in order to demonstrate that Taylor Frigon growth companies can be found in many different industries.*

That is certainly the case for the classic Taylor Frigon growth company Coach Inc (ticker symbol COH).* Founded in 1941 in a loft in Manhattan New York, and inspired by looking at old baseball gloves and seeing the way they burnish with age (see the burnishing in the image above of the iconic glove of Willie Mays), Coach has since grown to become one of the most-recognizable luxury brands in the world. Their high-quality premium lifestyle accessories now include handbags, accessories, apparel, travel goods, business accessories, footwear, and fragrances, but it all started with quality leather handbags that sought to emulate the classic burnished baseball mitt!

Coach sells their merchandise through upscale Coach stores in the US and other countries (especially the Asia Pacific region), as well as through wholesale distribution to department stores, specialty stores, and duty-free stores located in over twenty countries. The company is taking advantage of the spread of economic freedom to other countries in the world (such as China, where economic freedom was horribly absent for decades), which enables more people to start businesses, contribute to others by providing desired goods or services, earn more money, and then improve their standard of living, some of which they often choose to spend on quality luxury goods such as those provided by Coach.

With the majority of their items priced between $125 and $400, Coach is more accessible and reaches a larger demographic than the typical European fashion house selling bags in excess of $700 or even in excess of $1,000 to $3,000. Coach’s competitive advantages also include the company’s carefully-maintained and distinctive brand, the quality of their materials, the store experience, a very high customer service level, and the existence of factory stores (typically located more than fifty miles from the nearest major market) to address a more value-oriented shopper.

Coach is the number one luxury bag brand in the US and the number two luxury bag brand in Japan. Future growth fields include new target markets within the US (such as the teen demographic successfully targeted with the introduction of the Poppy collection in 2010), further expansion into the men’s bag and small leather goods market, and its ongoing expansion into international markets.

* At the time of publication, the principals of Taylor Frigon Capital Management owned shares of securities issued by Coach Inc (COH), EZchip (EZCH), and CH Robinson Worldwide (CHRW).

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Debt doom-and-gloomsayers

The headlines these days are thick with fearmongering over impending debt crises.

In the US, politicians from both sides of the aisle declare in stentorian tones that a failure to raise the debt ceiling (or, in some cases, a decision to raise the debt ceiling) will put the US Treasury in danger of default. Credit agencies are threatening to downgrade the US government's credit rating, due to the country's impending inability to service an ever-growing debt burden.

Elsewhere in the world, fear of a Greek debt crisis has pundits in the financial media declaring that conditions are right back to the summer of 2008. Greece's inability to service their own outsized debt, it is predicted, will set off a domino effect which will cause European banks to implode, sending the economy back into a panic crisis like that of 2008-2009, or worse.

While recognizing that bloated spending by governments is a serious problem (a problem so serious, in fact, that we have called it "The Question of Our Time" in previous discussions on this blog), we nevertheless disagree with the doom-and-gloomsayers predicting certain catastrophe from seemingly every street corner of late.

As the graph above created from data provided by the Federal Reserve Bank of St. Louis illustrates, the US is in no real danger of defaulting on its debts. The graph shows Federal receipts (the money that the US government takes in, primarily in the form of taxes) versus Federal outlays on interest (the money the US government must pay to service its debt). The top line in blue represents the receipts, and the bottom line in red represents the outlays, and it is clear that there are more than enough receipts to service the debt.

If we were to create an analogy for ease of understanding, the top line would represent a household's income (taxes being the "income" of a government), and the bottom line would represent that household's periodic mortgage payment. In the case of the US, this is a household that has a bigger mortgage than any other household in the world, and a bigger mortgage than at any time in the nation's history. However, it is also true that if the US were a household, it would have a higher income than any household on the block, and that its income was higher than at just about any time in its history as well.

To suggest that this household might seriously have problems paying its mortgage is ridiculous. The data shows that Federal receipts total almost $2.2 trillion, while the interest on the nation's debt is closer to $250 billion. This situation is analogous to a household with an annual income of around $2.2 million and an annual mortgage of around $250,000. If such a household was complaining that it needed an additional home equity line of credit in order to be able to pay all of its bills, one might reasonably ask what on earth it is spending all of its money on. It might need to cut back on some of its other discretionary spending, but most families would not stop paying their mortgage first -- if anything, that is the one bill that absolutely needs to be paid. If the US Treasury doesn't pay the service on the debt, it won't be because of lack of income.

Thus, all of the talk about a US default is really a gigantic red herring. The real problem is outsized government spending. In our analogy, the household with the $2.2 million annual income appears to have joined so many charitable organizations, signed up for so many expensive club memberships, and purchased so many subscriptions to worthwhile but expensive products and services that it is wondering if it can pay them all and still pay the mortgage. It is these extras (which in the case of the federal government are government programs on which it spends the tax receipts) that need to be cut and which are causing the budget pressure.

Similarly, the European debt problem also stems from over-zealous spending on programs that might have seemed like a good idea at the time, but which have completely overwhelmed the ability to pay the mortgage. In countries such as Greece, which doesn't have a very large income to begin with, there is a very real possibility that it will be unable to service its debt. However, as we have written before, the answer for every country that finds itself in this unfortunate circumstance is to increase its income through policies that promote economic growth and innovation -- not to raise taxes, the death-knell of economic growth!

In spite of the very real problems in Greece (and the likelihood that the Europeans will try to fix them in many of the wrong ways, stifling growth instead of encouraging it), we don't think the debt situation there is about to cause an economic Armageddon either. As economist Scott Grannis wrote over the weekend, the recent fears of "Carmageddon" in Los Angeles over the closing of Interstate 405 turned out to be unfounded -- as so often happens, it's usually not the crisis that you're expecting that turns out to be the real problem.

While the rest of the US and the world frets over impending debt-driven doom, we would advise investors to simply continue looking to invest their capital with well-run, growing companies, positioned in front of fertile fields for future expansion.

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Tax loopholes and corporate jets

It seems like everyone is talking about "tax loopholes" these days, on both sides of the aisle, with President Obama making accelerated depreciation of corporate jets into a symbol of everything that he believes is wrong with such "loopholes."

In the CNBC clip above, Dan Hubbard of the National Business Aviation Association notes that in a recent speech the president singled out corporate jets eight times in twenty minutes. The CNBC reporter points out that the "loophole" in question (accelerated depreciation for equipment purchased by corporations, equipment which includes private jets) was signed into law by the president himself in his own stimulus plan of 2009, although the idea was first enacted by Congress after 9/11 almost ten years ago and was enacted again in 2003.

While the jet industry spokesman gives plenty of coherent arguments why his industry's "tax loophole" should be spared from scorn and criticism, we would argue that there is a bigger issue here, and that is the principle of why we as Americans ever enacted a tax system that invites so much "engineering" in the first place. In fact, we would argue that the current debate exposes everything that is wrong with a progressive tax system that awards deductions for those industries and causes which can convince lawmakers that they are more worthy of special tax incentives than others.

We have written many times before about the fact that there are always consequences (often unintended consequences) whenever the government decides to tilt the playing field for the benefit of one player or another -- see for instance "Christina Romer and the strong versus weak dollar debate" or "The ugly tomatoes of protectionism" or "Government interference, Wall Street bonuses, and unintended consequences."

We would like to see a flat tax which eliminates all the arbitrary tax breaks awarded by politicians to producers of ethanol, or producers of biodiesel, or drivers of hybrid cars, or those who own homes rather than renting them, or those who loan money to municipalities by buying tax-free bonds, or any of the entire host of "loopholes" that have been enshrined in the tax code over the decades. However, we fear that politicians on both sides of the aisle are generally unwilling to remove the "loopholes" in the tax code that benefit one constituency or another.

While we believe it is hypocritical of the president to attack loopholes that benefit owners of corporate jets when he signed those loopholes into law in the first place, we believe that such loopholes are no more distasteful when they benefit private jets than when they benefit any other industry. This is an aspect of our convoluted tax code that more citizens should understand.

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Steve Forbes asks, "Why is Greece such a basket case?"

American businessman and champion of economic freedom Steve Forbes has written an important article entitled "For Whom the Greek Bell Tolls." It should be required reading for all investors.

Mr. Forbes brings up many excellent points, some of which we have emphasized previously in this blog, such as the importance of pro-growth policies rather than "austerity plans," as well as the problems with lavish pay for an ever-expanding force of government employees (some of the details he adds to this discussion are breathtaking).

He also provides some details about the primitive state of property rights in Greece, and the lack of effective procedures for registering property. This is an extremely important point, and one we have discussed before. We recommend all our readers take the time to visit this previous post and watch the excellent video embedded therein, in which Peruvian economist and advocate for property rights, Hernando De Soto, explains how the ability to formally register private property is at the heart of the rule of law and the ability to advance economically.

For those who wish to understand why Greece is such an economic basket-case (in spite of the fact that people of Greek descent are as innovative and successful in other countries as the members of any other group of human beings), Steve Forbes' article is highly recommended.

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A perspective on the overvalued / undervalued debate

Here is a link to an article from economist Scott Grannis, who writes the very insightful Calafia Beach Pundit blog.

In it, he adds to his ongoing argument that equities are not currently overvalued, using evidence including the forward earnings ratio of the S&P 500, which has been higher than corporate bond yields for the past year.

The earnings yield is the inverse of the PE ratio, and represents the percentage of earnings each dollar invested in a stock represents. Earnings yields are typically lower than bond yields, because investors are compensated by the potential for earnings growth in a stock (a potential which a comparable bond does not possess). The fact that earnings yields for stocks are now generally higher than the yields of comparable bonds indicates that investors have a very pessimistic view of the potential for future earnings growth.

Other market observers, such as Morgan Stanley equity strategist Adam Parker, have recently argued the opposite position from Mr. Grannis, saying that the market may be overvalued. This Wall Street Journal article explains Mr. Parker's position, which says that while large-cap stocks in the S&P may be cheap, the rest of the index is slightly overvalued. Mr. Parker also believes that estimates of future earnings are too high and "seem likely to fall back to earth," according to the Journal report.

Our position is that trying to predict the next price move -- or the next earnings trend -- of an entire index is a fool's game, and that such exercises fall into the same trap of failing to focus on individual businesses that is the hallmark of Modern Portfolio Theory (which we recently discussed in this post).

While it is useful to look at overall earnings yields and it is also useful to know that large-cap companies have not participated in the positive price move of the past two years to the same extent that smaller cap companies have, we do not advise that investors take that information and try to time the market with it, either by shifting from stocks to bonds based on such statistics, or by shifting from small-cap to large-cap names either. All of these are common techniques of investment processes that focus on large categories, sectors, or indices rather than on individual businesses themselves.

We agree with Mr. Grannis that stocks in general are not overvalued at this time, and we would use that information to encourage investors to continue regular, systematic investment into the securities of well-run, carefully selected businesses. With such regular and systematic investments, investors will be able to buy more of an investment when securities are undervalued, and will buy less when markets are overvalued.
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Happy 4th of July!

We at Taylor Frigon Capital Management would like to wish all our readers a very happy Independence Day this 4th of July.

We extend these wishes to readers who are not in the US as well, since we believe that the truths articulated in the Declaration of Independence on July 4, 1776 are universal human truths belonging to everyone by virtue of being an individual human being -- they are not granted by one government or another but are "self-evident," "unalienable," and "endowed by their Creator."

We also feel it is appropriate to sound a note of optimism this July 4th, as so many in the United States and the world at large are beset by fears of a new debt crisis triggered by Greece which will engulf the world, 1970s-style hyperinflation, or some other form of "global train wreck" on its way.

While there are certainly significant economic problems -- almost all of them induced by harmful if well-intentioned forms of government intrusion or downright socialism (even if "European-style" socialism) -- we would point out that investors can acknowledge these problems while still acknowledging the fact that in the long run, the system of freedom, rule of law, limitation of government, and right to private property established by the Founders has led to the greatest advances in human productivity and prosperity that the world has ever known.

On the other hand, systems in which the government levies excessive taxes in order to support pension and benefit systems such as those enjoyed by certain government employees in Greece (and in California!) inevitably self-destruct. We have argued that the attention this fact is now getting is at least a silver lining to the clouds over Europe.

However, those who are predicting that America is already worse off than Greece (including many voices in the United States from both sides of the political spectrum) are overlooking the fact that the United States is producing more than it ever has in its history, and continues to be the home of innovation and entrepreneurship (yes, even in California!).

We believe that amidst all the current negativity, this weekend would be a good time to relax, consider the benefits of the liberty and rule of law envisioned by the signers of the Declaration of Independence, and be thankful for the society that their vision made possible.
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