Buffett Bought Retail -- Should You?

U.S. consumers are reportedly getting crushed beneath massive indebtedness and soaring unemployment. Yet two of the world's greatest investors, George Soros and Berkshire Hathaway's (NYSE: BRK-A  ) (NYSE: BRK-B  ) Warren Buffett, just upped their stakes in the world's largest retailer -- Wal-Mart (NYSE: WMT  ) .

Do they know something we don't? Is it time to start buying retail?

To examine whether the retail industry may be bouncing back, and which retailers are the best bets, I asked the investing team at Motley Fool Hidden Gems one simple question: What's your favorite retail stock?

Stan Huber, senior analyst
Retail scares me a little at present, because of the recent run-up in stock prices. That said, my favorite name in this space currently is Tractor Supply. It has a reasonable moat, a large amount of recurring business, and strong operational management. It is also still a strong growth story that scales well, and it's being funded from operating cash flow.

Tractor Supply is a niche business serving recreational farmers, ranchers, and local tradesmen in thriving rural communities. Its largest business segment is the sale of equine, pet, and animal products such as food, cages, and medicine -- a regular and recurring source of business. It also sells tools, garden equipment, clothing, and everything else you could imagine for the rural lifestyle.

The company has a focus on customer service and stocks an inventory of both brand-name products and private-label goods. It proved resilient during the recession and expects to eventually double the number of stores in its chain. This is definitely one to have on your retail radar.

Mike Olsen, senior analyst
I'm reluctant to call a purchase of Wal-Mart stock an endorsement -- or condemnation -- of the U.S. consumer and retail stocks. You could call it a positive signal, but you could also reference the oft-cited Wal-Mart "trade-down." So unless Soros and Buffett start buying retail stocks en masse, I wouldn't call this anything.

I think the U.S. consumer built up above-average levels of debt and below-average savings in recent years, and I can't see a reason why that's a sustainable phenomenon. So, given the recent run-up, I can hardly call myself bullish on retail stocks.

I do, however, think that stock pickers can still scout out some good opportunities in retail, and I think one of those opportunities is CarMax (NYSE: KMX  ) . The price isn't fabulous at these levels, but its no-haggle model, focus on providing value to customers, and wealth of sales data leave it ideally positioned. And with Cash for Clunkers done with, I think folks are more likely to opt for used cars than new.

Nate Weisshaar, senior analyst
I think the deleveraging of the American consumer is far from over, and I believe that will result in a hole at the midpriced level of the retail spectrum. Most shoppers will be looking for the best deals, while the more fortunate shoppers will continue to pay up for high-quality, premier brands -- albeit less frequently. The winners in this scenario will be the Wal-Marts of the world on one end, and the Luxotticas and Coaches (NYSE: COH  ) on the other.

The retailers that rely more on the whims of fashion-chasing teenagers will likely be left blowing in the wind -- hot one season, cold the next, with no real clarity on the future. Wall Street hates uncertainty more than anything else, so while well-run operations will make it through, there will be blood. Investors will have to pick carefully if they plan to venture into this industry.

Andy Cross, Hidden Gems co-advisor
Retail stocks always garner a lot of attention from individual investors, because we know the stores and the products. Almost everyone has shopped in a Target (NYSE: TGT  ) or J.C. Penney at some point during their lifetime. That personal connection goes a long way for investors, because it makes the business far easier to understand than that of, say, a reinsurer or semiconductor manufacturer.

But that doesn't necessarily make retail companies more successful. In reality, long-term successful retailers like Tiffany are the exception, rather than the rule. Yet every investor likes to think he or she has found "the next Wal-Mart" when investing in some hot, fashionable start-up.

That's why, when it comes to retail stocks, I prefer to focus on winners that have dominated and expanded their niche for years. Staples (Nasdaq: SPLS  ) comes to mind. It basically created the office supplier superstore, and now it's pushing its expertise online and into supply distribution, two niches that didn't exist 15 years ago. It also has a growing international operation, so it's not 100% dependent on U.S. consumers.

That's also why I like Coach. Its successful launch into China has sown seeds that the handbag fashion icon will reap for years -- just as it did with Japan in the 1980s.

Seth Jayson, Hidden Gems co-advisor
I think the "Soros and Buffett love Wal-Mart" story will be misunderstood on many levels. First, this doesn't indicate any particular love of retail. Buffett hasn't always been successful in his forays into retail, and because of its size, Wal-Mart is one of the few retailers that Buffett can even consider investing in. We could even consider this a bet against retail -- that is, Buffett and Soros assuming that Wal-Mart is the beast that will gobble up the rest of its retail rivals.

Retail is tricky, and I have a hard time liking most of the companies in this industry. They're at the mercy of fickle consumers, and unless they're careful, they don't have much of a brand to fall back on. I prefer hybrid companies with strong niches, like Fossil and Guess? -- both of which I own.

These two companies have founder-led cultures, high insider ownership, great cash flow production, and brand names that resonate internationally. They do much of their business in wholesale or partner channels, but they've been growing their own retail presence in select markets, in order to capture more of the margin where possible.

Trouble is, neither has looked particularly cheap for the past six months. But then again, both have outperformed peers and expectations over that time period, and if they do things right in Europe and Asia, it's hard to see the ceiling. That's why they're both Hidden Gems portfolio candidates.

Want to get a look at the entire candidate list for Hidden Gems, along with the Hidden Gems real-money portfolio? Take a free 30-day trial.

Berkshire Hathaway, Coach, and Staples are Motley Fool Stock Advisor selections. Berkshire Hathaway, CarMax, and Wal-Mart Stores are Motley Fool Inside Value picks. Fossil and Guess? are Motley Fool Hidden Gems recommendation. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletters today, free for 30 days

Fool contributor Matt Koppenheffer owns shares of Berkshire Hathaway, but does not own shares of any of the other companies mentioned. The Fool's disclosure policy has never once been caught with its pants down. Of course, it doesn't actually wear pants...


Read/Post Comments (11) | Recommend This Article (27)

Comments from our Foolish Readers

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 November 23, 2009, at 12:39 PM, rzfool wrote:

    I like Aeropostale (ARO). They make and sell value priced clothing for the nearly recession-proof teen market. They have 900+ stores and are adding about 100 more each year. They have added a new brand aimed at pre-teens and are expanding into Canada. They have plenty of cash and no debt. They have solid management and have been around for 20 years.

    I own shares in Aeropostale.

  • Report this Comment On November 23, 2009, at 12:46 PM, madmilker wrote:

    he also bought a train....does tat mean everyone needs to buy train tickets....dang! everyone knows he bought into China before he double down on retail....the nice people of China are making stuff but RETAIL makes NOTHING!

    Maybe if sum of the O' rich farts of the world would reinvest in the American worker in order for America to make stuff....you wouldn't seen George Washington today imprisoned in a foreign bank....but what do i know...i jus pull teats for a living!

  • Report this Comment On November 23, 2009, at 12:46 PM, madmilker wrote:

    he also bought a train....does tat mean everyone needs to buy train tickets....dang! everyone knows he bought into China before he double down on retail....the nice people of China are making stuff but RETAIL makes NOTHING!

    Maybe if sum of the O' rich farts of the world would reinvest in the American worker in order for America to make stuff....you wouldn't seen George Washington today imprisoned in a foreign bank....but what do i know...i jus pull teats for a living!

  • Report this Comment On November 23, 2009, at 12:46 PM, madmilker wrote:

    oops!

  • Report this Comment On November 23, 2009, at 12:52 PM, madmilker wrote:

    oops!

  • Report this Comment On November 23, 2009, at 2:41 PM, OlleEgg wrote:

    Who says that Buffett only buys Wal-Mart because of the industry? Maybe it's because of the brand and the costumer influence. Or maybe he thinks that Wal-Mart is undervalued.

    I personally prefer Walgreen. It has a good line of products and a solid balance sheet with very little debt. It also has a lot of cash, which makes it possible to survive the recession or expand even more internationally. Walgreens pharmacy service division keeps the costumers loyalty because of the products on prescription, or just the costumers that are happy with Walgreen.

    By the way, i'm only 15 years old, so i'm not saying that i'm an expert.

  • Report this Comment On November 23, 2009, at 2:42 PM, OlleEgg wrote:

    Who says that Buffett only buys Wal-Mart because of the industry? Maybe it's because of the brand and the costumer influence. Or maybe he thinks that Wal-Mart is undervalued.

    I personally prefer Walgreen. It has a good line of products and a solid balance sheet with very little debt. It also has a lot of cash, which makes it possible to survive the recession or expand even more internationally. Walgreens pharmacy service division keeps the costumers loyalty because of the products on prescription, or just the costumers that are happy with Walgreen.

    By the way, i'm only 15 years old, so i'm not saying that i'm an expert.

  • Report this Comment On November 23, 2009, at 11:16 PM, daydaygoes wrote:

    Buffett bought BNI , I really wanna buy some stock of the BNI also, but how I can do it now?

    So that is laways the problem. If Buffet thought some company really valued, he just simply buy it in whole! Our other small guys do not even have a chance to touch...

  • Report this Comment On November 23, 2009, at 11:21 PM, daydaygoes wrote:

    Where is my post??

  • Report this Comment On November 27, 2009, at 3:10 PM, AngryNative wrote:

    Soros and Buffet purchase of retail stock is more bet on the US inflation increasing. With so much dollars being printed, and the near zero interest rate, those dollar are bound land up in Main street sooner or later. its the best way to protect your self against inflation (hyper-inflation), either buy commodities or food.

  • Report this Comment On November 29, 2009, at 5:49 PM, bc0203 wrote:

    Buffett bought Wal-Mart for two reasons:

    1. We're probably heading into a double-dip recession.

    2. if healthcare reform in it's current form passes, it's going to break the backs of smaller retailers, leaving Wal-Mart to pick up their customers..

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