Tiffany TIF reported very strong second-quarter results, with sales and earnings growing 30% and 58%, respectively. The company's narrow economic moat is evident in the current pricing environment, as diamond prices are rising rapidly and Tiffany's supply chain and ability to raise prices to its premium customers is creating a tailwind for sales and margins. We plan to raise our fair value estimate to account for the better-than-expected sales and earnings and also a modest impact from the long-term effect on margins of Tiffany's supply agreements, which we believe are becoming more valuable in the current environment. Longer term, we like Tiffany's brand and sustainable competitive advantages, but we are also cautious that demand, particularly from foreign tourists, could weaken precisely when prices start to come down. We believe the market is currently not pricing this possibility into the stock, which we still view as overvalued.

In the quarter, sales rose 30% year over year. Earnings rose 33%, to $0.86 per share, or 58% excluding some one-time charges for moving the headquarters building in New York City. Comparable-store sales (which don't include exchange rate effects) rose 22%, new stores contributed 2%, and the remaining 6% gain was due to the relatively weaker U.S. dollar. Even the usually weak region of Japan was up 8% on a comparable basis, and 22% if the effect of the strong yen is included, as is the case with the reported numbers. We believe there was some demand rebound from the March 11 earthquake, as Tiffany's first quarter ends in April and most companies in our coverage have said sales patterns have come back around in Japan, even being stronger than normal. We believe Tiffany's sales also represent a greater percentage of planned purchases, which can be delayed but are not lost if there is a natural disaster.

Looking longer term, we see value in Tiffany's supply chain and even its purchasing agreements, which will enable the company to continue to secure supply if demand (and thus price) continues to rise. Tiffany benefits from its long vertical supply chain, as it has inventory that may include stones and rough diamonds purchased at previously lower market prices. In the case of falling prices, the company is insulated in that it may not have to lower retail prices as much as competition, but there would eventually be a situation where the cost of the inventory could be a headwind to sales and margins as the costs of stones in inventory will not have caught up with the market. While it is difficult to predict global commodity prices, recent news from London and Belgium suggests diamond prices have at least paused and current levels are unsustainable. Additionally, rough diamond prices have risen nearly double that of finished goods (which were still up 15%-20% in the first half of the year). We believe the higher demand at the front of the supply chain compared with the end sales to consumers could mean dealers and wholesalers are holding back supply in the hope of selling at higher prices. Such dynamics in the past have served to increase volatility, raising prices short term but then causing a rush to sell when prices come down.