Despite rising inflation and supply shortages, retail stocks on average have doubled the return of the S&P 500 index in 2021, but there are a few leaders in the sector still worth considering.
Amazon (AMZN -0.59%) and Target (TGT 0.06%) are entering the holidays with healthy inventory levels, which could lead to surprise earnings results when these companies report holiday results in a few months. Here's why these are great stocks to buy right now.
Investors are not giving the e-commerce juggernaut enough credit for the relatively strong position it's in heading into the holidays. For retailers to meet expectations for sales growth in the near term, it's imperative they keep warehouses well-stocked with inventory, which has gotten more difficult in recent months with bottlenecks at the ports. But Amazon has been well-prepared for this scenario.
This time a year ago, Amazon entered the holiday quarter with inventory up just 15.8% over the same period in 2019. This year, Amazon's inventory was up 30% year over year entering the fourth quarter, which shows the progress it has made to expand capacity amid supply chain disruptions. If customers can't find what they need at smaller stores, Amazon may benefit this holiday season, with its plentiful inventory position.
Another advantage is wages. Amazon is paying workers an average of $18 per hour, well above minimum wage. This gives it an edge in keeping its warehouses well-staffed despite the labor shortages impacting many industries right now. Amazon is on track to double its fulfillment capacity over the two-year period since the pandemic began, and its willingness to pay higher wages is certainly helping the online retail giant accomplish that goal.
Investors were likely disappointed with how these investments in inventory and labor are weighing on profitability, not to mention lower guidance for revenue, which is forecast to increase between 4% to 12% year over year in the fourth quarter. But the lower growth partly reflects tough comparisons to the year-ago quarter, when Amazon experienced higher sales from holding its Prime Day event in October, whereas it held the event in June this year. This means investors shouldn't extrapolate these lower growth numbers out through 2022.
Amazon's investments in expanding fulfillment capacity will lead to more satisfied customers, who can take advantage of same-day and one-day deliveries, and potentially win Amazon even more Prime subscribers that get sucked into the Amazon flywheel. Expectations are low right now, which makes it an ideal time to consider buying shares in the e-commerce leader.
Target is perhaps in an even stronger position than Amazon. The bullseye giant finished the recent quarter with inventory up 40% since January. Target has delivered great returns for investors over the last year, with the stock price up 211%. That puts Amazon's one-year return of 8.65% to shame, but Target's growth streak is not over.
Target reported stellar comparable sales growth of 12.7% for the fiscal third quarter, on top of 20.7% in the year-ago quarter, which shows a lot of momentum heading into the holidays.
Management is certainly pressing all the right buttons to get customers in the door. During the recent earnings call, management credited the partnership with Ulta Beauty that has over 100 shop-in-shops in Target stores, in addition to positive results from Apple products.
Most importantly, customers are not just going to Target to shop a specific brand. Target reported consistent growth across merchandise categories, which is a sign that these partnerships are benefiting Target's brand as much as the Apple or Ulta Beauty ones.
With momentum heading into the most important quarter of the year for retail, on top of Target's strong inventory position to meet demand, the stock is still a good investment. The stock's forward price-to-earnings ratio is currently 18.15, which is a discount to the broader market's multiple of 21.3. At these valuation levels, Target could still deliver good returns off these highs.