Are Luxury Shares Too Luxurious?

The high-flying issues may already have peaked

Economists call it "the wealth effect." When stock prices rise, consumers feel rich and go shopping, often visiting such temples of indulgence as Cartier, Louis Vuitton, and Bulgari. Sure enough, as stock markets boom around the globe, makers of luxury goods are reaping the rewards. The bull markets aren't just creating new buyers of jewelry, perfume, and expensive leather goods. They're also providing fertile ground for initial public offerings. European luxury-goods makers such as Gucci, Tag Heuer, and Leica all launched new issues in the past year.

But many luxury stocks may already be approaching their price ceilings. Tiffany & Co. shares have nearly doubled since the beginning of the year, and Italian jewelry maker Bulgari has seen its stock rocket by 109% in the same period. Price-earnings ratios for some well-known companies have moved into the mid-20s and even 30s (table). That has led some professional stock pickers to conclude that the group's momentum could soon fizzle out.

Made up of only about 10 of the biggest and best companies, the luxury stock group has unique fundamentals that look positive right now. Newly rich Asians, Latin Americans, and Russians indulge in ever more conspicuous consumption. Developing-country demand also hedges against cyclical downturns in the industrial world. Overall, demand for luxury goods is expected to grow by up to 10% annually for the next several years.

But picking stocks isn't easy. Some big names, such as LVMH-Moet Hennessy Louis Vuitton, take in a wide luxury-brand market that includes cognac and champagne. Switzerland's SMH, whose Omega, Blancpain, and Rado watches cost $800 and up, also makes the plastic Swatch. And fashion is, finally, fashion. Says Bob Smith, a portfolio manager at Rowe Price Fleming International in Baltimore: "When you're hot, you're very hot. And when you're not, you're very not."

Gucci knows about hot. Bolstered by designer Tom Ford and a management team focused on brand expansion, Gucci has lately found favor with the luxury set. Merrill Lynch & Co. analyst Edouard de Boisgelin says Gucci can expect 20% sales growth and 25% earnings growth annually for the next five years as it adds about 16 new stores to its existing 67. That makes the stock's p-e ratio of 30 on current earnings still seem reasonable. Morgan Stanley & Co. analyst Claire Kent thinks Gucci's share price could reach $87 over the next 12 months, and Rowe Price Fleming's Smith sees $100 by 1998.

ALREADY SOUR. But Gucci seems to be an anomaly among luxury stocks. For example, Bulgari's jewelry is legendary, its perfumes are strong sellers, and it is planning lines of silk scarves and luxury eyewear. It will also open 26 new stores over the next couple of years. But some analysts think the gleam on its stock will tarnish. With a p-e ratio of 37, "in the short run, Bulgari can't deliver gains in share price," figures Giuseppe Albanese, Italy analyst at MarketScope Europe, a unit of Standard & Poor's.

Some luxury success stories have already turned sour. Tag Heuer, the Swiss maker of trendy upscale watches, went to the New York Stock Exchange in September with an IPO that is barely ticking along. Offered at $19, the stock is languishing at around $18. Some pros have doubts about management strategy and orders from Japan.

Many other classy names have seen their shares stall. After hitting a high in May, LVMH shares have fallen 15%. First-half results showed profits growing just 5%. Some pros think LVMH is losing market share to rivals such as Gucci. John Wakely, an analyst with Lehman Brothers Inc. in London, is one of several analysts who recently downgraded the stock from a previous buy recommendation.

At another French luxury flagship, Hermes International, shares nearly tripled in 18 months to a historic high of $284 in May. But since then, the family-run business has seen its stock slide 11%. CS First Boston analyst Cedric Magnelia figures that Hermes' high reliance on sales of its trademark silk scarves means "growth doesn't look robust."

Meanwhile, London-listed Vendome Luxury Group, maker of Cartier, Piaget, Montblanc, and Alfred Dunhill products, has seen its other, weaker brand names fall victim to competition in jewelry and watches. As a result, shares in the 30% of the company not held by Swiss group Richemont have stagnated at around $4 all year, substantially underperforming the London market.

Some observers think new luxury-stock opportunities may appear over the next year or two as more European family-owned companies go to market. Among the names dropped on the chic streets of Paris and Rome: France's Lancel and Italy's Trussardi, both leather-goods makers. Until then, though, those who feel wealthy might be better off treating themselves to a luxury trinket than taking a flier on its maker's stock.

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