Many retailers look cheap right now, with some trading at low-double-digit P/E multiples. But with stagnating economic growth and a tightfisted, ham-handed Congress doing little to help the economy, is now the time to buy retail stocks? After all, if earnings decline, those low P/E ratios are illusory.
I asked three Fool.com analysts what retail stock they liked best right now (if any) and then posed another question: Which retailer do you need to avoid?
Here's what they said:
Rick Munarriz, Fool.com contributor
I'm not a fan of P/E, and it has nothing to do with the way I looked in gym shorts back in high school.
Let's take two retailers. Video game specialist GameStop (NYSE: GME ) is trading for a mere eight times next fiscal year's projected profitability. High-end athletic apparel retailer lululemon athletica (Nasdaq: LULU ) is fetching 45 times next year's bottom-line target.
Which stock is cheaper?
This isn't really a trick question. I fully expect value investors to gravitate to GameStop as they shield their eyes from the lofty multiples that lululemon is commanding. However, I am not a value investor. I need growth in my diet, and in GameStop I see nothing more than a small-box tenant in a strip mall that will fade in relevance as digital delivery transforms the gaming industry.
I see more than $100 yoga pants at lululemon. Its latest quarter was a stunner, with sales and earnings soaring 35% and 70%, respectively. There aren't too many apparel retailers clocking in with net margins of 18% out there. Good luck finding a company that has been posting double-digit spikes in comps and trouncing Wall Street estimates since the recession began to ease last year.
Shoppers can be fickle, so it will be important to keep an eye on lululemon. The moment well-to-do soccer moms begin shopping elsewhere, investors will need to follow suit. However, its prospects -- even at its seemingly rich valuation -- are better than a company trying to sell new and used games and gear to teens who will be even more fickle when technology moves them along.
Alyce Lomax, Fool.com contributor
Wal-Mart (NYSE: WMT ) shares look good -- it's a powerful, ubiquitous discount retailer that looks reasonably priced. Its price-to-earnings ratio is just 12, a tad lower than rival Target's (NYSE: TGT ) . Wal-Mart shares certainly look a lot cheaper than many retail stocks right now.
Still, investors should beware for a few reasons. Wal-Mart's still struggling here in the U.S. Many of its core customers are living paycheck to paycheck amid price inflation. It's so desperate to drum up customer traffic it recently embarked on a gas price war. For a while, it even looked like it was losing sight of its price-cutting advantage. Bottom line: Wal-Mart's been faltering in an environment it should have been able to dominate, so look out below.
Costco (Nasdaq: COST ) may not look like the cheapest retail stock (it trades at 25 times earnings), but it's the best. I've said it before and I'll say it again: Costco has a wonderful management team, treats its employees well, and lures a higher-end clientele than many discount retailers do. Those who know the importance of small businesses to the U.S. economy also know that Costco's focus on bringing value to that group is a pretty incredible competitive advantage in these ugly times. Investors should choose Costco over Wal-Mart for the long-term win.
Rich Smith, Fool.com contributor
I've been negative on hhgregg (Nasdaq: HGG ) for quite some time. I know a lot of people like the stock -- it's even a Motley Fool Stock Advisor recommendation -- and a lot of people like the stock even more after Best Buy's first-quarter report last month, which Wall Street interpreted as signaling that hhgregg might exceed expectations.
I'm still not one of those people. When I look at hhgregg, I see a company that after years of generating free cash flow, turned into a net-cash-burner over the past four quarters. That's not a company I want to own.
Whom do I prefer? Ascena Retail (Nasdaq: ASNA ) . The company with the funny name used to be the company with the frumpy name "Dress Barn." Read past the label, though, and you'll see Ascena earned $184 million over the past 12 months and generated $183 million in free cash flow. It did this despite a huge increase in capital spending. At 15 times earnings and free cash flow, Ascena's priced right where it should be for predicted 14% annual earnings growth -- but it's exceeded growth expectations in three of the past four quarters.
Foolish bottom line
So there you have three Fools' opinions on retail. Do you have another great play in this sector? Let us know in the comments section below.
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