Tiffany & Co reported a smaller-than-expected quarterly profit as sales of lower-margin rough diamonds rose faster than its pricier and more profitable jewelry, and its shares fell 2 percent.

Tiffany's gross margin fell 0.7 percentage points to 58.7 percent during the quarter, in large part because of the rough diamond business, which stems from the resale of diamonds the company does not polish for its own use and one that hardly generates any profits.

Tiffany said it has had to contend with what it called volatile swings in the price of precious metals and diamond prices since 2008, hitting margins last year.

Wall Street Strategies analyst Brian Sozzi attributed the earnings miss to a nearly fivefold increase in the wholesale diamond sales as well as fewer new ways left to cut costs.

Price deflation in Japan, which was the only market where sales fell during the quarter, and a shift in product assortment in the United States had also hit Tiffany's margins more than Wall Street had expected, Sozzi said in a note.

Sozzi maintained his buy rating on the stock but lowered his price target to $52 from $58.

Tiffany's net income rose nearly fivefold to $140.4 million, or $1.10 per share, in the fourth quarter ended on January 31, from $31.1 million, or 25 cents per share, a year earlier.

Excluding one-time items, Tiffany's profit from continuing operations came to $1.09 per share, falling short of the analysts' average forecast of $1.13, according to Thomson Reuters I/B/E/S.

BETTER VIEW THIS YEAR

The upscale jeweler expects gross margins to improve by 1 percentage point this year as the lower cost of diamonds and precious metals bought kick in, with profit from continuing operations at between $2.45 and $2.50 per share. Analysts had forecast earnings of $2.43 per share.

Tiffany's shares have more than doubled in the past year, and have risen 9 percent since the company raised its dividend on February 18.

This is a classic case of overly high expectations, said Jefferies & Co analyst Randal Konik. The stock has risen a lot lately, so this slight miss has pushed shares back down.

Despite the hit to its margins, Tiffany got a boost as luxury spending made a comeback over the holidays.

At Tiffany's flagship store on Manhattan's Fifth Avenue, which accounts for up to 10 percent of its global revenue, sales rose 22 percent during the quarter. Same-store sales were up 11 percent at U.S. stores. Global sales rose 17 percent to $981.4 million.

Sales were particularly robust in Europe, where they rose 29 percent. Tiffany estimated worldwide sales would rise 11 percent this year.

It also now appears that media reports from a year ago predicting the demise of luxury and full price spending were most certainly exaggerated, Chief Executive Officer Michael Kowalski said on a conference call.

Many consumers were simply waiting for their finances to improve, Kowalski said. He said Tiffany had begun the year with worldwide sales growth exceeding our first-quarter plan.

New York-based Tiffany operated 220 stores as of January 31 and said it planned to open 17 new ones this year.

In anticipation of a better climate for jewelry spending, Tiffany said it plans to raise inventories in the high-single-digit range.

(Reporting by Phil Wahba; Editing by Derek Caney and Lisa Von Ahn)

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