The excitement over the decline in unemployment that was announced on Oct. 5 was somewhat muted, as Americans awaited the Thomson Reuters/University of Michigan consumer confidence results slated for Oct 12. After several disappointing months of consumer sentiment, investors were waiting for the other shoe to drop. Turns out the angst over the most important economic indicator of all -- the mood of the nation's consumers – was all for naught.
Depending on which study you subscribe to, consumer spending drives as much as 70% of the country's economy. So, the latest consumer sentiment figures showing the highest level of confidence in more than five years was welcome, to say the least. Now the question is, which companies stands to gain the most? Now that we're heading into the all-important holiday shopping season with increased optimism, the two stocks with the most appreciation potential are Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) -- still.
The case for Wal-Mart
Virtually all industries benefit when consumers are feeling warm and fuzzy, but the most direct route to profit for investors are the retail and consumer goods industries. On the retail side of the aisle, there are two industry behemoths that stand head and shoulders above the rest.
The first is $255 billion retail leader Wal-Mart. Already up 27% for the year; Wal-Mart shareholders have enjoyed a nice run in 2012. If you're a value investor, it'd be easy to see Wal-Mart's stock price appreciation year-to-date and think to yourself, 'dang, missed it by that much!' Thankfully, by every imaginable financial measure, Wal-Mart remains a gem hiding in plain sight.
Nearly all of Wal-Mart's competition in the retail industry -- at least those of any size worth noting -- are significantly more expensive on an earnings basis. Industry and analyst darling Costco (NASDAQ:COST) trades at 25 times earnings, Dollar General (NYSE:DG) shares are at nearly 19 times trailing earnings, and low-cost alternative Dollar Tree (NASDAQ:DLTR) is about the same. With a P/E of just under 16, ROA and ROE that stacks up to anyone in the sector, and solid margins, Wal-Mart should be at the top of any retail investor's list.
Wal-Mart's recently announced capital allocation plan update for fiscal 2014 should appease uncertain investors, if any remain. Cost saving measures are on track, as Wal-Mart seeks to shave 100 basis points of operating expenses as a percentage of sales by 2017. For a company that generates about $450 billion in annual revenue, that's a significant 1%. Next fiscal year's plan also calls for continued emphasis on Wal-Mart's online sales strategy, which currently generates about 2% of overall sales. This is an area of real opportunity, along with the roll-out of about 100 new, smaller Neighborhood Markets.
The case for Target
In a lot of respects, Wal-Mart and Target are eerily similar. Both have been, and continue to be, somewhat neglected, as investors flock to Costco and low-cost clothing retailers, like Dollar General, Dollar Tree, and Macy's. Both Target and Wal-Mart have taken heat for slow electronic sales. It's one of the few areas of concern for Target, as consumers shift to online purchases.
As it happens, Target has more than made up for sluggish electronic revenues in other areas. Same-store sales increases are the norm for Target, with September's 2.1% increase one of its lowest in months. But if that's 'disappointment,' I can live with that.
Also, much like Wal-Mart, Target is a screaming value, boasting an industry low (other than the mom and pop shops) P/E of 14, and price to sales, and price to book ratios, at or near rock bottom relative to others. And let's not forget Target's income component -- its 2.35% dividend yield moves it to the head of the class, barely surpassing Wal-Mart's 2.12%.
Recent consumer sentiment and employment numbers are indicative of the economic stars (finally) aligning. Combined with the mayhem that is the holiday shopping season nearly upon us, retailers are set to have a rousing end to 2012. Don't let the 27% appreciation in Wal-Mart's year-to-date stock price, or the 20% jump in Target shares, throw you off. Both Wal-Mart and Target offer appreciation potential their competitors can't match, and now U.S. consumers are feeling better than they have in years.
Fool contributor Tim Brugger currently holds no securities positions mentioned in this article. The Motley Fool owns shares of Costco Wholesale. Motley Fool newsletter services have recommended buying shares of Costco Wholesale. 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.