A Matching Pair of Stocks

Lately, retailers have been suffering from a general malaise. Symptoms vary from Pier 1's (NYSE:PIR) lack of unique merchandise to Wal-Mart's (NYSE:WMT) blaming higher fuel costs for slowing sales growth (whether that excuse is legitimate or not is material for another Take).

Maybe it's imprudent to suggest investing in retailers at this point, but the value investor in me loves sniffing around for quality stocks when the Street throws 'em on the sale rack.

Two competitors I've become interested in are the global athletic footwear and apparel powerhouse Foot Locker (NYSE:FL) and the much smaller, but faster-growing Finish Line (NASDAQ:FINL). My Foolish colleague Seth Jayson commented earlier that these companies were not attractive despite recent drops in the stock prices. I, however, disagree. While sales growth has been cause for concern lately, at current valuations these turnaround stories represent compelling values.

Yes, Foot Locker and Finish Line have recently lost traction because of slipping same-store sales and profit warnings. But let's roll back the tape and see whether there's not more to this story than a couple quarters' worth of results.

Just a few years ago, Foot Locker was a shining example of what Peter Lynch likes to call "diworsification" -- that is, diversification that merely serves to confuse investors and worsen long-term performance. In fact, it wasn't even called Foot Locker -- it was Venator Group. Its subsidiaries included a hodgepodge ranging from The San Francisco Music Box Company to Burger King franchises.

Meanwhile, Finish Line's stale merchandise lineup consistently failed to ring up sales. Diluted EPS steadily shrank from $1.02 in 1998 to $0.15 in 2001, when net income totaled a mere 0.6% of sales. That's the same year the company ate $12.5 million in after-tax "repositioning and asset impairment charges" -- about as pretty as watching the Cubs throw away their 2003 World Series chances (but I'm not bitter).

Both companies made sweeping changes and have since built a steady record of sales and earnings growth. Not to mention, both are now dividend payers -- a key indicator of confidence in future growth prospects. It's certainly better to see cash returned to shareholders than thrown away in an unrelated fast-food franchise.

To illustrate where the two companies stand compared with similar competitors, here is some valuation data for The Sports Authority (NYSE:TSA) and Brown Shoe Co. (NYSE:BWS).

Foot Locker and Finish Line are currently trading at discounts to these two competitors based on the P/E and P/TBV ratios. The PEG ratio also indicates that both Foot Locker and Finish Line are reasonably priced.

Of course, there's more to consider than just a few ratios. The chart above doesn't even touch on the larger companies, like Dick'sSporting Goods (NYSE:DKS) and Wal-Mart, fighting for a share of the athletic and sporting goods market. While Finish Line appears to have plenty of room to grow, it could struggle trying to differentiate itself from these many competitors. Foot Locker faces the same issues, but its global footprint and brand name enable it to gain partnerships with the NFL, NBA, and ESPN, which should give it an edge over other retailers.

Regardless, both companies are looking more like playoff contenders these days (rather than a certain baseball team I still root for). I believe there is opportunity here for long-term investors to gain from both earnings and valuation growth.

To read more Foolishness about shoe retail, try these on for size:

• Can You Say Adibok?
• Through the Finish Line
• A Stock to Play Footsie With

Have thoughts on Foot Locker or retail you need to get off your chest? Share them with fellow Fools at our discussion boards.

Fool contributor Jason Ramage looks forward to hearing your feedback. He owns shares of Pier 1 Imports and Foot Locker.