It's Survival of the Fittest for Retail

In case you haven't noticed, retail is under attack. To me, it looks like natural selection is under way for the industry. Many of the big-name stores we've known for decades -- and in some cases a century or more -- are headed toward extinction unless they evolve. It's not a strong balance sheet, "able" management, or economic recovery that will dictate the future of these companies -- it's fundamental retailing strategies that will determine the retail outlets of the future. For investors now, though, the group of cheaply priced retail stocks offers big opportunity for those that can identify the winners of the retail survival of the fittest.

What it takes
It has never been easy to be a player in the retail game, but now it's even harder. With the Internet quickly taking over the world, what's a store owner to do?

For a company like Best Buy (NYSE: BBY  ) , it's been a losing battle. The easy response is to say that consumers can buy everything on Amazon.com (Nasdaq: AMZN  ) , but that's not entirely true.

Let's imagine a Best Buy store and see what we can easily purchase elsewhere. The DVD/Blu Ray section has no need to exist; we can buy that stuff guaranteed cheaper on the web. The chargers, cases, and every other accessory for phones and tablets -- yeah, that can come from Amazon for far less, too. Most of the home theater equipment can easily be bought online for a nice discount as well. But Best Buy, despite 91% lower profits in the latest quarter, has a few things Amazon can't offer. The company's in-house television and home theater brand, Insignia, offers value-priced goods to consumers that they can take home the same day for near the same price they would pay for a discounted Panasonic on Amazon. By selling private-label brands, the company has fewer slices of the profit pie to give out. The same goes for its cable and accessory private label, Rocketdog.

Best Buy is far from a model retailer, but they have a kernel of what it takes to be a modern-day retailer -- namely, offering products and services you can't find elsewhere.

Unique is key
Even ultra-low priced stores like Wal-Mart (NYSE: WMT  ) will have trouble in the future. Sure, they can offer hundreds of thousands of products in a single store, but that single store is becoming less appealing to customers. A 100,000 square foot warehouse is overwhelming when batteries and cat litter can be ordered with next-day delivery from the comfort of your living room. Smaller, more navigable stores like Family Dollar offer similar prices for essential items right on the corner of Main St.

Convenience and low prices certainly help, but there still needs to be more for the retailer of tomorrow.

Home Depot (NYSE: HD  ) , for example, is a well-positioned retailer in the Amazon era. Buying bulk lumber, paints, concrete, and anything else is something we need to do in person. And it's not even appealing for Amazon, because shipping 500 pieces of a low-margin product like sheet wood just doesn't help the income statement enough after shipping costs and logistics come into play.

Perhaps this is why, while Best Buy's profits are sinking faster than the Bismarck, Home Depot recently reported double-digit bottom-line growth (that, and a coming housing recovery).

The takeaway here is the same as above: Offer something you can't find or don't want to find on the Internet, and you will still have a business.

The lux bucks
I can buy 50 undershirts on the Internet for next to nothing that I know will more or less fit. With flash sales, I can pick up a nice pair of shoes for a great discount. As usual, the heavily discountable items are best purchased from e-tailers (e-tailors, in this case). But for the wealthy luxury buyers, it still pays to go into the store to try on that $1,000 blouse.

That's why a company like Nordstrom (NYSE: JWN  ) has a one-year return of nearly 45%. The company sells to a high-end market and offers a fantastic in-store experience. I love to walk into Nordstrom's, paycheck in hand, ready to spend it all on a belt buckle, listening to a nice elderly man play the piano while some dude next to me is buying 12 pairs of $500 jeans.

Well, maybe I don't love that, but it's better than T.J. Maxx.

That 45% capital appreciation in one year still yields an affordable stock -- Nordstrom trades at only 14.4 times forward earnings. Compare that to Costco's 21 times forward earnings for a business that, while brilliantly run, sells at the lowest possible margins and is subject to millions of bananas going bad.

The point is, the next time I am in the market for a new suit or an overpriced dress shirt, I am not buying online (not with this figure).

Foolish bottom line
Retail is cheap right now, folks. Investors and analysts are scared that Amazon and its web-based friends will shut down everyone except the Wal-Marts and Costcos. It's true, some of these retailers will die if they don't figure a way to offer something we need to see before we buy. But for well-insulated stores like Home Depot and Nordstrom, these are names that will be around for a lot longer, regardless of what the next batch of Internet-dweebs create.

If you're a retail investor who's taking a look at the company disrupting the space, make sure to check out our new premium report on Amazon. Whether you're looking to own Amazon or own one of the companies it's stealing sales from, understanding Amazon and its prospects is essential. Our report has you covered. To get started, just click here now.

Fool contributor Michael Lewis owns none of the stocks mentioned above. You can follow him on Twitter @MikeyLewy. The Motley Fool owns shares of Amazon.com and Best Buy. Motley Fool newsletter services have recommended buying shares of Amazon.com and Home Depot. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 25, 2012, at 9:45 PM, neamakri wrote:

    Just a passing thought on Walmart. Yes they have hundreds of thousands of items, BUT not always what you want.

    Example; Last year I needed a new electric shaver. I wanted to buy a plug-in shaver, no batteries (my preference). Walmart has a large selection of shavers with batteries, NONE just plug-in.

    Ditto Target.

    Bottom line: I spent $44.95 plus tax at Walgreens to get what I wanted. They had fewer choices than Walmart, but had exactly what I wanted, so Walgreens got my business.

    If you don't believe me, next trip to Walmart try to buy a small bottle (3-4 oz.) of talcum powder. Good luck!

  • Report this Comment On August 26, 2012, at 11:38 PM, RayK1800 wrote:

    Who buys into online shopping for daily or need to find items. You don't.

    My favorite stores are TGT, HD, and Macy's.

    Amazon's niche is buying at a discount online for larger ticket items. There's a reason people go to TGT, WMT, Macy's, etc. it's to get out of the house. Sitting in front of the computer is not a real life.

    Argue about that all you want, but your article is more a pump for AMZN and trying hard to justify it.

    Oh, and I buy cameras, lenses, software, mostly from AMZN, but won't be buying groceries there.

    See, my argument is as subjective as yours.

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