ETF Teardown: The Best Retail Stocks

Noted for their simplicity and other advantages over mutual funds, exchange-traded funds have become a popular investing tool.

ETFs hold a collection of stocks that share certain elements. For example, if investors are bullish on continued consumer confidence in the economy, they can buy shares in Retail HOLDRs, which holds a diverse set of retail stocks including top holdings Home Depot (NYSE: HD) and Target (NYSE: TGT).

Since this ETF invests in a number of stocks, its diversity limits your upside. For an investor who's, say, really hip to niche online retailers, but more wary of large brick-and-mortar chains, this ETF wouldn't fit the bill.

Fear not, Fool -- in this edition of "ETF Teardown," we'll look for ways to discover the best retail stocks. To help, we'll use Motley Fool CAPS, our tool for screening and ranking stocks and stock pickers.

The power of tags
To help investors quickly locate great stocks, the more than 5,300 stocks CAPS rates can be "tagged" with descriptors that group the company with others sharing certain qualities -- "Biofuels," for example, or "Metal Fabrication."

The "Retail" tag returns 22 companies that include some of the largest retailers around the globe, covering everything from grocery to clothing to pharmacy. This particular collection of investments hasn't done too well in the past year, dropping 10.8% versus a 1.6% gain for the S&P 500 index.

To gauge which companies the CAPS community thinks offer the best opportunities in retail today, we'll sort these businesses by their CAPS star ranking (from one to the maximum five stars). We'll then examine each individual company to see who -- from Wall Street to Main Street -- is bullish or bearish on the business, and why.

Getting down to the nitty-gritty
Here are some retail stocks gleaned from CAPS today.

Company	CAPS Rating	Retail Segment
Walgreen (NYSE: WAG)	****	Drugstores
Costco (Nasdaq: COST)	****	Discount variety
CVS Caremark (NYSE: CVS)	****	Drugstores
Sears Holdings (Nasdaq: SHLD)	***	Department stores
99 Cents Only Stores (NYSE: NDN)	**	Discount variety

Writing on the Walgreen
With the price of Walgreen's stock down 19% year to date, investors may be wondering if the doctor ordered the wrong prescription for the drugstore chain operator. Most of the shortfall in shares came with the most recent earnings report, which actually didn't look that bad considering the intense competition from other drugstores. Even with the pricing pressure that comes with generic drugs, Walgreen kept up its pace of 16% annual earnings growth.

Like larger competitor CVS Caremark, Walgreen has been taking large doses of acquisitions lately to bolster a health-care business that is constantly changing. Most of the challenges come from increased competition from alternative chains like Costco and Wal-Mart -- companies that are using their hefty size and store traffic to drop the price of medications. Battling falling reimbursements for drugs, Walgreen and other chains look to income from higher-margin sources such as general merchandise and foods.

With the recent drop in the stock, many CAPS investors are talking about increasing their dosage of Walgreen stock. Often citing solid management and an aging population, 1,088 out of the 1,160 investors rating the company believe it will beat the market in the future.

Seriously Sears
Broad-line retailer Sears doesn't muster the same holiday-season shopping enthusiasm from investors, however. Like Walgreen, stock in Sears Holdings has taken a beating in the last few quarters as the retailer has continued to struggle with falling comps at Kmart and Sears locations, leading up to a huge earnings miss in the most recent quarter.

Much more debate swirls around Sears and the tack the company has taken with chairman Eddie Lampert at the helm, though. While Lampert has been credited with turning things around at the retailer since 2004, the recent retreat underscores that the retail operations are still not anything to write home about. But some investors and even a few Fools think the recent turmoil is merely a bump in the road to longer-term success behind a genius investor and hedge fund manager.

The polarized feelings on Sears are reflected in the ratings the CAPS community has on the company -- a full 25% of the CAPS All-Stars who cast a vote on the company are bearish on the prospects of Sears Holdings going forward.

Lead a horse to water ...
Plucking individual retail stocks is, of course, a high-risk endeavor. Investors should always perform their own due diligence on companies rather than take a recommendation -- after all, even the best stock pickers can be horribly wrong.

Do you agree that drugstores are the best place to invest in retail today? Or are department stores a better play? Give your own opinion in Motley Fool CAPS.

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