The word on Wall Street is that retailing will be healthiest at the high-end this holiday, but jewel-hungry investors expecting a big breakfast at

Tiffany

(TIF) - Get Report

may end up losing their lunch.

After a horrendous third quarter, the stock is down 7% from its postelection spike, and analysts say that the jeweler -- whose brand once held the aura of actress Audrey Hepburn -- has lost its cachet. Recent efforts to broaden its customer base have backfired, and shifts in its competitive landscape have dulled the company's edge.

"Tiffany is basically a tourist trap now," said Howard Davidowitz, chairman of Davidowitz & Associates (he doesn't own a position in Tiffany and has no banking relationships with the company).

"For years, they have looked smart for winning new customers by getting tourists to buy these $100 gift items so they can carry that blue bag and be a big shot with their friends. Now, from a marketing point of view, there's a downside to that strategy. I think we're seeing that it has diminished their brand," Davidowitz said.

Other high-end players like

Neiman Marcus

(NMG)

,

Saks

(SKS)

and Bergdorf Goodman have expanded their jewelry businesses to take share. Those looking for a bargain can head to

Wal-Mart

(WMT) - Get Report

for a diamond ring, and savvy shoppers are turning to online jewelers like

Blue Nile

(NILE)

"The high-end luxury business is great now for a lot of players, but it's not so great for Tiffany because they tried to mix the masses with the classes, and they are not a pure luxury business anymore," Davidowitz said. "When you are a specialty retailer, you cannot lose touch with your core customer."

In its third quarter, Tiffany's profit dropped 26% from the year-ago period, falling short of its own estimates, and it lowered its earnings forecast for 2005. The major factor in the disappointment was a 5% decline in same-store sales in Japan, where the company derives nearly a quarter of its revenue. It had been tinkering with its product mix there, but to no avail.

"One thing that sets Tiffany apart from a lot of high-end retailers is its exposure in Japan," said Scott Rothbort, president of Lakeview Asset Management (he has no position in the stock). "A lot of Tiffany's fortunes tend to come and go with the fortunes of Japanese shoppers. I wouldn't exactly call this a great time for wealth in Japan."

One of the company's plans to improve profit margins was based on a relationship started in 1999 when Tiffany took a 14% stake in a Canadian company called

Aber Diamond

(ABER)

to help finance the development of the Diavik mine, Canada's second diamond mine that just began producing last year.

Aber agreed to sell rough diamonds from the mine to Tiffany at a discount, while Tiffany agreed to buy $50 million worth every year for 10 years after the site was up and running.

Late Tuesday, Tiffany announced it was selling its stake in a brokered deal led by Merrill Lynch to several financial institutions. Under the terms of the deal, the jeweler no longer will be able to buy diamonds from Aber at a discount. Aber paid the company $268 million, the present value of the original sales agreement. Meanwhile, Tiffany is still required to buy $50 million worth of diamonds each year until 2013. Tiffany's chief financial officer, James Fernandez, had just resigned from Aber's board of directors.

"There was no strategic need for us to own

Aber's stock anymore," said Mark Aaron, vice president of investor relations at Tiffany. "Five years ago, there was a strategic necessity in making the investment in Aber so that they would have the necessary funds to develop the Diavik diamond mine. Five years later, the mine is up and running. Things are going well. We're buying diamonds, and we wanted to monetize the asset and invest it into our business. They agreed."

In the two days following the announcement, the stock tumbled 2.3% while the S&P Retail Index rose 1.8%.

Davidowitz said investors were likely responding negatively because they view the breakup as a response to Aber's move in April to buy a 51% stake in Harry Winston, a smaller, high-end jewelry chain whose flagship store is a mere block away from Tiffany's in Manhattan.

"These guys compete directly on the high-end," Davidowitz said. "How can they be partners in the same business? You can't be in bed with your competitor.

"Now, rumor has it that Harry Winston has plans to expand here and in Japan," he added. "This is just another wind blowing against Tiffany."

Aber could not be reached for comment, and a spokesperson at Harry Winston said no one at the company was readily available to comment.

J.P. Morgan analyst Brian Tunick said the move was a positive development for Tiffany, but he did not change his neutral rating on the stock because the "business is facing a more competitive landscape, and sales and margin improvement will be tough to post," (Tunick does not own a position in Tiffany, but his firm does have a banking relationship with the company).

Adding to the pressure,

De Beers

has plans to join the party after the diamond cartel ended almost 60 years of legal wrangling in the U.S. by pleading guilty to a 10-year-old charge of price-fixing and paying a $10 million fine. The privately owned South African company that owns more than 50% of the world's rough diamond supply has plans to bring its joint retail venture with luxury goods group LVMH to New York. De Beers LV has jewelry stores in London and Tokyo and it's poised to set up camp in the Big Apple, from where Tiffany derives about 10% of its revenue.

Some hope Tiffany's salvation lies in diversification. In the last three years, it bought a chain of duty-free jewelry and watch stores in the Caribbean Islands called Little Switzerland, and an upscale jewelry designer, Temple St. Clair.

More recently, it launched a new concept called Iridesse that specializes in selling pearls. So far, there are two Iridesse stores open in Virginia and New Jersey, with price points ranging from under $100 for small, pearl stud earrings to over $40,000 for necklaces with pearls and diamonds.

The company plans to open 20 Iridesse stores over the next five years, and J.P. Morgan's Tunick believes the U.S. market eventually could accommodate 30 to 40 of them.

Still, growth is expected to slow in the coming years. After growing sales at an annual average of 11% over the last five years, its sales are expected to add 28% this year, followed by 10% in 2005 and 8% in 2006.

On a valuation basis, Tiffany has come down from a price-to-earnings ratio of around 27 to 22 in recent weeks. Still, Neiman Marcus trades closer to 14, and despite missing estimates for November sales growth, it is widely cited as a high-ender set to outperform this Christmas.

"I could see Tiffany coming down a bit more until it gets to a level that's more fairly valued," Rothbort said. "At these prices, I wouldn't put Tiffany at the top of my shopping list right now."