High-Octane Plays for the Retail Rebound

 | Mar 19, 2012 | 10:30 AM EDT
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The "shop-'til-you-drop" mentality hasn't quite returned, but evidence is mounting that the retail industry is on the mend. Thomson Reuters has reported that, among 18 large retailers it's surveyed, same-store sales jumped 4.7% in February. That's far beyond the 3.4% increase predicted by analysts.

Returns in the fiscal fourth quarter (ending in January) were lit up by a strong holiday season, with solid sales gains seen in a variety of retailers -- from Home Depot (HD) to Bloomingdale's, a division of Macy's (M).

Further, the Census Bureau says February retail and food services sales rose 1.1% vs. last year, and total sales between December and February were up 6.4%.

All of this has gotten the attention of investors, and they've been pushing up retail stocks in response. In some cases, that's meant new all-time highs, including in shares of Costco (COST) and Limited (LTD).

Among the retailers you might want to pick up right now is the biggest of them all: Wal-Mart (WMT). The retailer faces challenges, as its primary target market of lower-income consumers continues to struggle economically, and these folks have been increasingly shopping at dollar stores. But this has not stopped Wal-Mart from being aggressive in its growth strategy, including rolling out a chain of smaller-format stores -- Wal-Mart Express -- for urban areas.

A stock-picking strategy I created based on the writings of James P. O'Shaughnessy thinks Wal-Mart is a good buy. The screen likes the huge market capitalization of $209 billion, increases in Wal-Mart's earnings per share in each of the past five years, and a price-to-sales ratio (a measure of how well priced is a stock) of 0.47. For that latter metric, 1.5 is the maximum allowable reading.

The O'Shaughnessy strategy's last step is to take all the stocks that have passed the previous three tests and to find the top 50 based on relative strength (which measures how well a stock has performed during the past year relative to the broad market). Wal-Mart's relative-strength reading of 79 places it within this desirable group.

Foot Locker (FL) is another tempting option. The company sells athletic footwear and apparel in about 3,400 stores in North America, Europe and Australia. Comparable-store sales for the most recent quarter showed a solid uptick of 7.5%, and Foot Locker is two years along in a five-year strategic plan designed to improve its financial and operating performance. The plan seems to be paying off.

Foot Locker gets across the finish line in style, according to my Peter Lynch-based strategy. The strategy focuses on the P/E/G ratio, which is price-to-earnings relative to growth, and measures how much the investor is paying for growth. A P/E/G of up to 1.0 is acceptable, and Foot Locker is kicking up its heels with a very desirable P/E/G of 0.54. Also in the company's favor is a very low level of debt.

Finally there's luxury retailer Coach (COH), whose leather goods can sometimes cost as much as a used car. Coach operates nearly 500 stand-alone retail stores in the U.S. and Canada, and has an additional 1,000-plus locations, in department stores and other formats, in more than 20 countries.

This company is liked by another one of my strategies -- one based on an investor who's famous for living in the same house he bought decades ago, even while his net worth rocketed into the stratosphere. My Warren Buffett strategy looks for companies with a "durable competitive advantage" -- and Coach, with this name recognition and chain of company-owned stores, has such an advantage.

In addition, the company has little debt, return on equity of 36.5% for the past 10 years and earnings that have gone up in nine of the past 10 years. The Buffett strategy also projects investors' likely annual return on their investment over the next 10 years, and Coach's projected return is of leather-bound quality at 18.3%.

You do not have to be a serial shopper to like retailers today. You just need to recognize that this industry is indeed undergoing a revival -- and you'd be wise to take advantage of it.

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