The 3 Best Specialty Retail Stocks to Buy in 2017

Winners in this troubled sector tend to have one thing in common: They've found (or inherently possess) an answer to Amazon.

Rich Duprey
Rich Duprey
Jun 3, 2017 at 1:00PM
Consumer Goods

In general, traditional retailers have not adjusted quickly enough to and the e-commerce revolution's upending of their industry. With consumers shifting an ever growing percentage of their spending online, the need for physical stores has been dramatically reduced, leaving many retailers with large numbers of underperforming stores to close. Some have descended into bankruptcy; others have "joined the other team," getting rid of all their physical locations and transitioning into online-only operations.

Yet some specialty retailers are not only surviving amid "the Amazon effect," they're thriving. Read on to see why Five Below (NASDAQ:FIVE), Party City (NYSE:PRTY), and Ulta Salon (NASDAQ:ULTA) , with their growing sales numbers and expanding store footprints, may be among the best specialty retailers today.

Boy holding a fidget spinner

Image source: Getty Images.

Five Below is hot

Where the dollar-store chains have enjoyed much success in selling primarily goods for a dollar or less, Five Below is outperforming them by selling merchandise for $5 or less. It's a price point the dollar stores are sensitive to: Dollar General (NYSE:DG), for example, notes more than 80% of its SKUs are at the $5 level or lower.

Yet where shares of Dollar General and Dollar Tree have lost 19% and 12%, respectively, over the past year, Five Below's stock prices is 25% higher. Earlier this year, it reported fiscal fourth quarter sales had jumped 19% to $388 million, with profits rising 17%. For the year, net sales were 20% higher. As a result, it's accelerating its store expansion plans.

Last year, Five Below opened 85 net new stores, up from 71 in 2015, and this year it anticipates opening as many as 100 locations. The key to the success that is powering that expansion has been finding what it calls "trend right" products: items it can profitably sell in its price range that make customers come back for more. In Q4, it noted that tech products caught customers' eyes, and said it looked forward to slime being a hit in Q1. It probably couldn't have predicted the sensation fidget spinners would become, but those will likely provide it with a substantial sales boost.

At 40 times earnings and 27 times next year's estimates, Five Below's stock isn't cheap, but the market seems to be willing to pay up for a retailer that has found the right combination of price, value, and profit.

People releasing balloons into the air

Image source: Getty Images.

Every day is a party

Halloween may be the biggest holiday for specialty retailer Party City, accounting for 20% of its total $1.25 billion in annual revenues, but who would guess that balloons were such a moneymaker too? The party supply chain reported global sales of metallic and latex balloons of $106 million in sales last year, or 8% of the total. And having just bought the biggest Australian balloon retailer Balloon Agencies, for $1.9 million, look for that percentage to rise going forward.

Party City has over 900 company-owned and franchised stores in the U.S. and Canada, making it the biggest coast-to-coast party center, but every year in September, an additional 250 to 300 pop-up Halloween City stores appear, selling all manner of holiday costumes, decorations, and more. Those alone generated $59 million in sales.

The celebrations leader is also moving more sales online, and last year e-commerce accounted for over $152 million. Despite its dominance in its niche, Party City's stock is cheap. It trades for 17 times earnings and 11 times next year's estimates, but also goes for a bargain-basement ratio of 11 times its free cash flow. That could make Party City one of the best values in specialty retail.

Various personal and beauty care products

Image source: Ulta Beauty.

No lipstick on a pig here

Beauty care continues to be one of the more more attractive segments in an otherwise ugly retail landscape, and Ulta Beauty remains one of the queens on the scene. Over the past two decades, it has become the top national beauty-care retailer, offering more than 20,000 products from over 500 vendors at 990 stores.

While not completely Amazon-proof, it is largely resistant to the e-commerce threat because most consumers want to touch and try on beauty care products before they buy. Of course, for those willing to buy such wares online, Ulta has its own e-commerce site; in its first quarter, the chain's online sales grew 71% to $104 million, adding 340 basis points to the specialty retailer's comparable-sales growth of 14.3%.

Ulta remains in brick-and-mortar expansion mode despite the growth of e-commerce, whether its own or its competition's. Its 10.4 million square foot total footprint was a better than 12% increase from the year ago period.

The beauty care specialist has a popular loyalty program with 24.3 million members, which has helped it gain market share across all of its major categories, and is particularly strong in prestige cosmetics, as well as mass and prestige skin care. It continues to focus on the  competitive advantage it derives from its teams of beauty-care specialists working in a salon setting.

This is another stock the market has bid up as investors chase success higher at 46 times earnings and 30 times estimates. The share price has advanced 30% over the past year, but analysts think it can handily widen earnings at a 20% clip annually over the next five years.