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The Only 4 Retailers Worth Buying

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The holidays are off to a strong start for retailers. After years of pent-up demand, it appears that consumers are actually shopping again.

If the next few weeks continue the initial uptick in activity, it's easy to imagine investors flocking back into the names that dot suburban mall directories. But Fools shouldn't want to buy into just any chain.

Brisk buying in general may lift most of the retailers, but you can do better than that. Single out the stocks that will continue to climb after this holiday season's unwanted gifts have all been traded in. There are essentially four types of bricks-and-mortar retailers worth your attention these days.

1. The Cost Leader
There may be no chain as polarizing as Wal-Mart (NYSE: WMT  ) , but as the world's largest retailer, it's able to achieve cost savings that its smaller rivals can't match.

Wal-Mart helps its cause, naturally, by running a consumer-friendly operation that keeps markups honest and relies on turning its inventory quickly to drive sales and profitability.

Comps have come under fire lately, and conventional wisdom suggests that shoppers who traded down to Sam Walton's discount store during the recession are now gravitating back to the more conventional department stores.

However, at the end of the days, shoppers will gravitate to where they can get the more bang for their buck. There will naturally be closeout specialists or chains that dominate thin niches, but when it comes to mass-market retailing, Wal-Mart is ground zero for all-weather shopping.

2. The Early Riser
The problem with many of the household names of retail is that they have already penetrated the market. There's nowhere else to grow, leaving investors at the mercy of swinging comps and margins to dictate highs and lows in a tight range. Established chains may sometimes roll out smaller sister concepts, but by the time that they move the needle, they've already saturated the market.

The solution, of course, is to catch chains earlier in their growth cycles.

One of my favorites is lululemon athletica (Nasdaq: LULU  ) . The Canadian retailer of high-end fitness apparel for women is doing well by catering to affluent yoga moms. Revenue soared 56% in its latest quarter, with earnings more than doubling.

As an upscale retailer, it did stumble a bit during the economic downturn. But it's on fire these days, with comps spiking 31% in its latest quarter on a constant currency basis. One worthy tidbit to consider as we head into next week's quarterly report: The company has beaten analyst profit targets by 25% or better in each of the three past quarters. Don't be surprised if lululemon earns more than the $0.25 a share that Wall Street predicts.

3. The Exclusive Brand
You'll never see me buy into specialty retailers just because they're hot at the moment. There really isn't much of a moat if you're Urban Outfitters (Nasdaq: URBN  ) or Abercrombie & Fitch (NYSE: ANF  ) , even if fickle teens are lining up at the register because your fashion buyers guessed correctly this season.

Your best bet is to buy into a retailer whose brand transcends any cookie-cutter concept.

At True Religion (Nasdaq: TRLG  ) , the brand is bigger than the concept. Everyone knows that it's a company selling high-end designer jeans. You can buy the company's fashionable denim through Neiman Marcus and even Zappos, but the best selection will logically be found at its namesake stores.

True Religion is coming off a record quarter in terms of net sales, though margins and profitability slipped from the year-ago period. Unlike many leveraged chains, True Religion's balance sheet is flush with cash and free of long-term debt.

4. The Foreign Exchange Student
There are plenty of investing opportunities in stateside operators, but international retailers offer a few refreshing attributes.

  • Several foreign economies are growing a lot faster than America's.
  • If the dollar weakens, sales in a country with a strengthening currency against the greenback will be even more potent.
  • Buying into a foreign retailer provides sector diversification. That'll come in handy the next time domestic shoppers clam up.

Unfortunately, there aren't too many retailers abroad that trade consistently on stateside exchanges, but China Xiniya Fashion's (NYSE: XNY  ) recent IPO bears watching. Xiniya specializes in casual yet fashionable apparel for young men. It has intentionally avoided China's larger cities, preferring to be the brand of choice in underserved second-tier cities with emerging workforces. It went public at $11 a share last week.

Investors who want to blend The Cost Leader with The Foreign Exchange Student can also dive into Wal-Mart de Mexico (OTC BB: WMMVY.PK).

More than four
One can argue that I shouldn't leave out the turnaround situations. Some of retail's biggest gainers will be chains on the brink of death that somehow manage to recover. But while I admire the fortunate few who can correctly guess which of these tenuous plays will pay off, I think most investors probably won't share their success. Why bother with the risk, when the path to picking out one of the four types of no-brainer winners is so easy?

Which retailer are you buying this holiday season? Share your thoughts in the comment box below.

Wal-Mart is a Motley Fool Inside Value selection. Wal-Mart de Mexico and Wal-Mart are Motley Fool Global Gains recommendations. The Fool owns shares of Wal-Mart. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Longtime Fool contributor Rick Munarriz thinks that shopping and shopping for retailer stocks are both "shop 'til you drop" experiences. He does not own shares in any of the stocks in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.

Read/Post Comments (4) | Recommend This Article (9)

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 December 02, 2010, at 2:43 PM, exdividendday wrote:

    If you like apparel store concepts, you should look at my list of 8 textile apparel stocks that pay highest dividends:

    The average dividend-yield amounts to 2.66 percent while the average P/E ratio is 25.70.

  • Report this Comment On December 02, 2010, at 4:03 PM, madmilker wrote:

    Six straight quarters of declining same store sales...

    No growth in Germany cause they got kicked out...

    No growth in South Korea cause they got kicked out...

    They sold Adsa to Corinth, a fellow Wal-Mart group company but now the seven directors will receive Asda's dividend payments....

    And with them proudly stating that they put over 95% China Made in all their stores in China on their China web page has a washtub full of Americans really ticked off.

  • Report this Comment On December 02, 2010, at 8:50 PM, wjcoffman wrote:

    Ok who told the oil companies there's pent up consumer demand for retail goods? As gas prepares to pass $3 a gallon there goes my Christmas Club savings. Bah humbug!

  • Report this Comment On December 02, 2010, at 11:57 PM, jamokey wrote:

    I'll take Costco over Wal-Mart any day. I own shares of both. I shop at both. It comes down to customer service. The workers at Costco seem to get it. I don't get the same feeling at WMT. Costco may not be a bargain at current prices, but I would buy it today and reinvest the dividends for 10 years and be very happy.

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