Rules of the Game: Shoppers Steadfast

 | May 02, 2013 | 10:00 AM EDT
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We love to shop. Online, offline. Men, women. Bad economy, worse economy. Doesn't matter. We love to buy stuff. There have been naysayers who believe various pieces of economic data prove that the consumer will be wilting -- any day now. Just wait. Really.

Utilities and health care are the best performing S&P 500 sectors year-to-date, but consumer discretionary, home to a number of retailers, is up 16.89% so far in 2013.

We hold a number of retail stocks within our equity overlay portfolio. It's called "equity overlay" because it complements our models that use exchange traded funds to give sector and regional exposure for clients in aggressive, moderate and conservative portfolios. The equity overlay adds exposure to a portfolio of carefully hand-picked individual stocks.

AutoZone (AZO) is one that I wrote about a couple of weeks ago. The auto parts retailer rallied to a new high on Wednesday, defying a broader market selloff. The company reports its third quarter on May 21. Analysts have pegged earnings at $7.23 per share on revenue of $2.22 billion. Both would be increases over the year-ago quarter.

Technically and fundamentally, there's plenty to like about this stock. The naysayers have predicted that business would suffer in an improving economy. However, the company, along with industry rivals, has proven that it can retain customer demand as the broader economy waxes and wanes.

The stock has many of the fundamental characteristics I look for. It has a strong track record of earnings and revenue growth over the past six years. Operating margins have expanded during that time, and free cash flow per share has also been on the rise.

The price-to-earnings ratio is 16, suggesting that there is room to run. I don't always use P/E to gauge whether a stock is buyable. But it is a factor worth evaluating, particularly when I'm looking at something like AutoZone, which has moved out of its explosive growth stage.

Costco (COST) is also in our portfolio. This company hails from the consumer staples sector, rather than consumer discretionary, which houses more retailers. It's understandable, I suppose. Who doesn't consider a palette of toilet paper or a vat of dill pickles to be household staples?

The company should report its third quarter later this month. It's expected to earn $1.03 per share on revenue of $24.28 billion, improvements on the top and bottom lines.

Other fundamental aspects bode well for the company. Membership renewal rates have remained high, despite the changing economic cycles and fluctuations in consumer confidence in recent years. U.S.-based mutual funds and hedge funds have increased their buying in the past year, another factor in its favor.

Costco rallied to a new high last week, then pulled back to find support along its short-term 5-day exponential moving average.

I always check the analysts' estimates when evaluating a stock. Estimates are frequently wrong, as we all know. Be aware that analysts can underestimate as well as overestimate, so it's not necessarily a case of Wall Street being overly optimistic. The estimates are a gauge, however, of institutional confidence in a company's potential for profitability.

Analysts see Costco growing earnings by 15% this year, to $4.55 per share, and another 11% next year, to $5.04 per share. That indicates expectation for solid growth, which, in turn, could lead to further institutional buying.

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