Beware Retail Stocks Gone Wild

Not so long ago, investors seemed to be avoiding most retail stocks like the plague. Unless the stock was Wal-Mart Stores (NYSE:WMT) or McDonald's, it seemed like nobody wanted to even think about retail stocks. Now, all of a sudden, the stocks of some specialty retailers have gone absolutely berserk.

In some cases, that performance doesn't seem to correlate with much of anything fundamental, and is particularly mystifying considering the nasty consumer spending environment.

Here are a few retail stocks that have gone wild lately. Let's take a look around.

*CAPS data as of 4/27/09. Revenue and profit growth are from the most recent quarter. Price appreciation is from MSN Money. Revenue and growth figures are from Capital IQ.

The wildest of the wild?
Some of these figures look absurd at the outset, but there may be more than meets the eye. With racy retailer American Apparel, there's always more (ahem). This company has long been known to consumers, in no small part thanks to interesting yet controversial CEO Dov Charney's alleged antics; its more recent scandals include a scuffle with Woody Allen over the use of his image in ads.

As outlandish as a 170% increase in its stock price over a few months may be, the stock had been battered pretty badly in recent times (its 52-week low was $1.20), and for good reasons. Late last year, a former employee filed a lawsuit against the CEO, and among the allegations was that he had reported some bogus inventory numbers to trick investors. More recently, the company faced loan obligations that some feared would have forced it into Chapter 11 bankruptcy, but a private-equity firm bought an 18% stake in the company just in the nick of time.

American Apparel's sales growth last quarter was extremely impressive, and its earnings moved into positive territory from the year-ago period, despite an ugly consumer environment. The company provides American-made T-shirts and other apparel that isn't too pricey and appeals to young hipsters. The stock is trading at almost 28 times trailing earnings now, but some investors think it may be a good growth stock over the next several years, even if it still contains its fair share of risk.

Still a little too wild
I can understand investors' hopes for American Apparel, since risky or no, its products and brand resonate well with young people. However, investor hope is a little harder for me to comprehend when it comes to J. Crew and Chico's, given their recent performances. Neither company reported a profit last quarter, and sales decreased at both retailers. I recently cautioned investors to look out below regarding Chico's, because not only is the economic climate extremely difficult, the retailer's been trying to turn around for years now, and it hasn't shown many signs of doing so.

Hot Topic also strikes me as risky; granted, unlike Chico's, it has been able to pull off substantial evidence of a turnaround after several years of malaise, but I've often wondered whether the faddishness of the Twilight franchise is going to wear off and leave it in the doldrums again. And its price-to-earnings ratio of 29 sounds steep when so many retail stocks are trading at far cheaper multiples. (My Foolish colleague Rick Munarriz recently recommended throwing the stock away, too.)

Citi Trends may have pulled off an impressive profit last quarter, but its large increase in costs should be a bit troubling to investors. It targets lower-income consumers, who may find themselves increasingly pinched for cash for discretionary clothing purchases. So, it may be a bit of a wild bet, even if Citi is showing remarkable resilience these days (and its lack of debt is a plus in my book).

Just wild enough
The Buckle sounds like the best of the bunch to me, even if it has only earned a mere two-star rating in CAPS. The stock has been performing quite well recently, and even better, the company's been performing very well during the recession, with consistently impressive same-store sales gains; its solid performance spans far more than a couple of quarters. (My Foolish colleague Kristin Graham took a deep look in late December.) There are no big controversies or worries surrounding the company. It has ample cash and no debt. And the stock's trading at a relatively cheap 16 times earnings.

Ever since the economy clearly turned south, I've thought investors should take great care when investing in retail stocks, and look for great brands, staying power, leadership qualities, and stellar balance sheets with plenty of cash and no debt. And it seems that even though months ago everyone was terrified of retail, the current rally has resulted in many investors rushing in madly, snapping up retail stocks that looked "cheap" simply in dollar figures, with little thought of competitive advantage or the companies' balance sheets.

There's no reason to go wild when it comes to retail. Given the current economic climate, I still fear many retailers may face extinction. But carefully searching for the retail stock winners should be good for investors who are buying for the very long term.