Despite relatively strong performances in the face of increasing online competition in recent years, both Nordstrom (NYSE:JWN) and Macy's (NYSE:M) have been caught in a sectorwide selloff. They've fought valiantly, but these storied mall-based retailers have seen their shares fall by as much as 40% amid lackluster same-store-sales growth in their recently reported third quarters.

Yet these two retailers aren't going anywhere anytime soon. Both continue to adapt to a world increasingly focused on Internet purchases, and successfully so. They remain solidly profitable and continue to generate good returns on invested capital, despite the negativity surrounding the sector.

So what's an investor to do? Go shopping, of course! Here's which one of the two should be first on your list.

How did we wind up here?
On Oct. 4, Nordstrom reported surprisingly poor results. The Seattle-based retailer, which had held up extraordinarily well since the depths of the 2008-09 financial crisis, failed to attract increased traffic in the third quarter. Macy's also reported lackluster sales growth when it reported, causing its shares to quickly sell off alongside Nordstrom's. Even J.C. Penney, the scrappy comeback kid of the sector, and retail stalwart Dillard's were dragged down. Simply put, few retail names were spared.

M Chart

Chart by YCharts.

Despite laudable results over the past five years, the group was sold off en masse simply because of one rough quarter. It seems likely that Wall Street has overreacted yet again. 

Valuation
Both Macy's and Nordstrom trade at sizable discounts to their long-term historic valuations:

M Chart

Chart by YCharts.

That's right, ladies and gentlemen. The S&P 500 Index trades at about 20.47  times current earnings, while these two cornerstones of the American retail experience trade for what amounts to an absolute steal. I know what you're thinking: There has to be a catch. Wall Street knows these companies won't grow much, and that's why they're trading for big discounts to their historic valuations and the market.

Sounds reasonable, right? There, too, you'd be wrong.

Macy's and Nordstrom join the dark side
To say online shopping has changed the retail experience forever would be a gross understatement. Heck, I did all of my holiday shopping this year online -- 90% of it on Amazon.com. (Go, Prime!). But you know what my wife did? She went to the mall. More specifically, she went to Macy's for a lot of her shopping. So did her two sisters. And their mother. So did millions of American consumers.

Consumers will always need to browse, try things on, and get a feel for what's out there in a way only physical shopping stores deliver. We can all buy a T-shirt online for $20, but when you start talking about $80 jeans or a $60 sweater, it's wise to try things on first. Macy's and Nordstrom (and most every other retailer for that matter) knows this. But they also know that people like the convenience, speed, and efficiency that online shopping provides.

What's a 100-year-old retailer to do? Adapt, of course. Close low-traffic stores. Invest less in physical inventory in favor of huge distribution facilities. Buy online specialty brands (as Nordstrom did with Trunk Club). Both Macy's and Nordstrom are doing all of this and more:

  • Macy's continues to shutter low-traffic stores in non-urban areas. In fact, it just announced a whopping 40 store closures to this end
  • Nordstrom continues to expand its off-price brand stores such as Nordstrom Rack.
  • Macy's continues to invest in omni-channel initiatives that include massive online fulfillment facilities that rival an Amazon.com warehouse, like the one it just built in Oaklahoma City,
  • Nordstrom now operates three massive supply-chain facilities in Cedar Rapids, Iowa, Elizabethtown, Pa., and San Bernardino, Calif.
  • Nordstrom's investments in fulfillment have grown 35% annually for the past five years.
  • Expected to spend $300 million in fiscal 2015 on fulfillment and distribution capex.
  • Nordstrom is in the process of testing curbside pickup at several locations in addition to rolling out a text-to-buy app.

There's a lot more investment in the future going on at these retailers than the Street is giving them credit for, and they're doing all of this while generating solid free cash flow numbers.

Nordstrom

 

FY 2013

FY 2014

FY 2015

Cash from operations

$1.11 billion

$1.32 billion

$1.22 billion

Capex

$513 million $803 million $861 million

Free cash flow

$597 million $517 million $359 million

Source: S&P Capital IQ.

Macy's

 

FY 2013

FY 2014

FY 2015

Cash from operations

$2.179 billion $2.549 billion $2.709 billion

Capex

$698 million $607 million $770 million

Free cash flow

$1.481 billion $1.942 billion $1.939 billion

Source: S&P Capital IQ

Which one is the best deal?
Now we come to the million-dollar question: Which of these two retailers is the real steal? It should be obvious to the reader by now that both of these brands are going to be just fine 10 years down the road. But if I have to pick a winner, it's Macy's. Its valuation, and its estimated earnings growth to the end of the decade, are just too attractive:

 

Macy's

Nordstrom

Recent price

$37

$48

Current P/E

8.8

14

FY 2020 Estimated earnings per share

$6.45

$5.43

Source: S&P Capital IQ.

I'm as big a fan of Nordstrom's operations as you'll find, but I know a good deal when I see one, and Macy's current valuation is just too good to pass up. Macy's is making all the right moves to adapt to the world we live in and is expected to generate decent earnings growth five years out, and all this can be yours for just 9 times current earnings -- and you don't even need a coupon. 

Sean O'Reilly has no position in any stocks mentioned. The Motley Fool recommends Nordstrom. 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. The Motley Fool has a disclosure policy.