Market Opportunity or Value Trap?

Timing the market is a losing game. However, that doesn't mean investors can't catch their favorite businesses on sale every once and a while. In a bull market, sometimes those opportunities are rare, and there's a sharp difference between buying a stock on sale, and catching a falling knife. Let's take a look at a company that has lost more than 15% of its share price in the past month. Are you catching a great deal, or just getting cut? Let's take a closer look.

Fashion sale?

URBN Chart

URBN data by YCharts

Urban Outfitters'  (NASDAQ: URBN  )  stock price continues to decline since its September earnings release, while the S&P 500 has been relatively flat. Urban Outfitters' net sales growth of 12% was solid, but the outlook for the third quarter for retail in general is expected to be soft, and this has surely weighed on Urban Outfitters' stock.

However, investors should remember a couple of key advantages which Urban Outfitters offers. Much like The Gap  (NYSE: GPS  )  operates multiple brands (Gap, Banana Republic, Old Navy, Piperlime) catering to different demographics, Urban Outfitters (Urban Outfitters, Anthropologie, Free People, Terrain, BHLDN) is diversified in its offerings. However, unlike Gap with its more than 3,400 global locations, Urban Outfitters has less than 500 stores today; this despite Urban Outfitters being founded in 1970, only one year after Gap. However, since its IPO in 1993, Urban Outfitters' stock has handily outperformed Gap's:

URBN Chart

URBN data by YCharts

There is also one remarkable aspect of this out-performance to consider. Urban Outfitter's trailing annual revenue of $2.95 billion is less than one-fifth that of Gap's $16+ billion in sales. Simply put, the better historical investment (at least since its founding) has been Urban Outfitters; it's also the company with a much larger growth opportunity ahead of it. 

But let's not ignore Gap's success going back to its beginnings. Investors who bought close to the IPO back in the early '70s, would now be up a whopping 50,000%, when factoring in dividends. That's a life-changing investment. The point? Just because Urban Outfitters is up over 2,000% doesn't mean the best money has already been made. 

Another way to diversify into retail
For investors looking to add retail  fashion to their portfolios, VF Corp  (NYSE: VFC  ) is worth a look. With popular brands like Wrangler, Reef, and 7 For All Mankind under the VF umbrella, there's a lot to like about this acquisitive clothier with both direct retail stores and brands available everywhere. VF management walked away from an acquisition of Billabong earlier this summer, instead of paying more than it deemed the business was worth. That's a positive sign that management will keep making the right acquisitions, and not just growth for the sake of growth.

Earnings announced on July 19 were stellar, with the company beating on both revenue and earnings, and raising guidance for the remainder of the year. The market does have high expectations, as shares are already up over 30% this year, and a forward price to earnings ratio of 18. Earnings are just around the corner (October 21,) so there could be some short-term volatility in the share price. It might be best to start with a small bite and add shares over time versus trying to time the market around earnings. 

Foolish final thoughts
Retail is tough, and being small relative to peers like Gap is no guarantee of growth. However, the short-term softness of retail and any headwinds that it causes certainly isn't reason to look past a well-run business like Urban Outfitters. On a valuation basis, its trailing P/E of near 20 looks like a great buy. It may not be The Gap in 20 years, but the potential is still worth a close look. Don't try to call the bottom. Look for signs of a successful future, too. 

 

Looking for more ways to invest in retail?
The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.

 

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