Kate Spade (KATE) stock fell 2.5% to $17.83 in Thursday morning trading after Bank of America/Merrill Lynch downgraded shares to "neutral" from "buy" on valuation. 

Shares of the luxury retailer have surged about 23% since The Wall Street Journal reported in December that Kate Spade was exploring a sale.

The report followed a November letter from hedge fund Caerus Investors urging the handbag maker to sell itself. 

Much of the potential gain from an acquisition is now priced into shares, the BofA/Merrill Lynch analysts said. They estimate a buyout value of $22 a share, but believe there are risks the stock will slip if a takeover doesn't occur.

BofA/Merrill Lynch has a $20 price target on the stock, about 11% higher than current levels.

The shares have a price-to-earnings ratio about 18 based on the firm's 2018 estimates, compared with 15 times BofA/Merrill Lynch's 2018 earning estimates for Coach (COH)  and nine times that for Michael Kors (KORS) .

"We think Kate's shares deserve a premium multiple given its near-term outsized earnings growth and free cash flow recovery opportunity," the analysts said. "However, we think relatively negative sentiment regarding the challenges in the affordable handbag category and outlet channel limit expansion" beyond 20 times earnings.

Kate Spade's popular Cobble Hill Small Toddy shoulder bag retails for $298.