Retail Remains a Tough Proposition

 | Jan 23, 2014 | 2:15 PM EST
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Over the past few weeks, I have watched the retail stocks with some amazement. Even as we continue to hear talk of an economic recovery, retail stocks are getting absolutely slaughtered in the stock market.

There are some valid reasons for this, such as the increased competition from online, but a tiny part of my brain wonders if an economy that is 70% consumer-driven is really all that healthy when the consumer-related retail stocks are getting hammered.

Our own Brian Sozzi (for my money, he is the go-to guy in retail stocks despite his WWE addiction) has talked about changes in the sector as store closings and downsizing have become the story of the day in brick-and-mortar retail locations. The industry is undergoing a change, to be sure.

My natural inclination is to sit down with my trusty screener and see if any stocks look like they may be "maximum pessimism" value candidates. Just looking at the S&P 500 so far this year, I see that seven of the 10 worst-performing stocks in the first few weeks of the year are retail or consumer-related stocks. Some of them look intriguing, and a few even trade below the all-important book value level that signifies a bargain in my deep-value view of the world. I took the list of bombed-out stocks and turned to my expert panel of retail experts.

My experts have an almost perfect record as retail analysts. They have helped me locate consumer-related bargains over the years, such as Foot Locker (FL) and Sketchers (SKX), which have tripled or even quadrupled over the next five years. It is really a simple process. I look for retailers that are getting crushed in the market and send my wife and the kids shopping at the nearest location. If they buy a fair amount of stuff, then the stock is probably going to recover, and I can apply my valuation parameters to determine an entry price.

When I tried that on today's losing retail stocks, I got a mixed bag. J.C. Penney (JCP) is a resounding "No." When the store was using the "everyday low price" strategy, my wife liked the store for staples such as jeans and my never-ending supply of tropical shirts. But now that management is applying a "who knows what they are doing?" strategy, she doesn't care for the store. My adult kids were unable to find anything they liked at a price they considered a bargain. The 10-year-old girl commented that the store was "boring."

None of them have been in a Sears (SHLD), and they see no reason to go into one ever again. The stores are unappealing, and we buy all the tools or appliances we need online. The soft lines are just a joke, according to my eagle-eyed crew. I couldn't even interest them in taking my money and going there for clothes.

Best Buy (BBY) is a winner, according to my shoppers. The kids are all heavy users of electronic gadgets, and they find it convenient to be able to get just about anything they want in one location. My 25-year-old son is in the store often, looking for new games or bargain prices on old games for his gaming console. I have a real fear that someday the 10-year-old will go in and never come out, as she loves everything in the place except the washing machines. My wife likes to try computers and laptops before she buys them, and Best Buy is good for that. All of us do admit to checking prices online to see if a better deal is available before buying.

The problem with Best Buy is that there is no reasonable way to conclude that the stock is cheap at this price. The shares fetch more than 2.3x book value, and my estimate of intrinsic value for the company is about $23 a share. The stock needs to drop another 3 points to be fairly valued and about 10 more to be a potential bargain purchase.

The surprise winner is Staples (SPLS). All of my analysts love the store for electronics, school supplies, furniture and what the little one calls "stuff you can use to be crafty." I confess that I have not been in an office supply store in years, as I have figured out that I can meet most of office needs by wandering around the exhibit halls of the Money Show and other investment conferences and obtain enough pens, highlighters and mini-staplers to fill my needs.

The stock is almost there in terms of valuation. The stock trades for 1.4x book value and about 75% of my intrinsic value estimate. If this stock gets down to the single digits amid the retail carnage we are currently seeing, then the stock is a serious candidate for purchase by long-term value investors.

If my crack retail team likes the store, the stock isn't cheap enough for serious consideration. If it's cheap, they hate the place. Retail remains a dangerous hinting ground for most investors.

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