Not even a month ago, many retailers' shares were priced as though their businesses would never grow again -- or worse, like they might actually shrink. Doomsday sales forecasts came out left and right. But retailers have once again proven the naysayers wrong.
In the last few days, share prices have reversed course as many retailers have reported fairly robust same-store sales. American Eagle Outfitters (NASDAQ:AEOS), Abercrombie & Fitch (NYSE:ANF), Wal-Mart (NYSE:WMT), Buckle (NYSE:BKE), and Motley Fool Hidden Gems selection New York & Co. (NYSE:NWY) have all announced healthy trends. Just a few weeks ago, those retailers and more were sitting on the bargain rack.
Conventional wisdom says that retailers' unexpected same-store sales improvement occurred because the weather during October was chillier than normal, leading shoppers to abandon the outdoor life and head for the mall. I've also read that weather, not rising energy costs, kept shoppers from the malls this past summer. It makes sense to me that high energy costs would hold shoppers back, but I don't buy the weather reason for one second. The weather is always going to change; making investing decisions based on the weather and its impact on one month's sales is about the most bizarre line of reasoning I can think of.
My disbelief goes deeper than mere sales projections. Companies have more than one lever they can pull to increase investors' returns, but the weather argument assumes that the only lever available is sales. Mind you, the sales lever is the most important one they have, and I like to see increasing sales as much as the next guy. But companies also have the option of buying back shares, paying dividends, or making their operations more efficient.
These other three levers get really interesting when companies start trading at low multiples to earnings or free cash flow (take your pick). The four retailers mentioned above were all trading below 15 times forward earnings estimates a few weeks ago, and a couple of them still are. You can also add beleaguered retailers like Motley Fool Stock Advisor pick Gap (NYSE:GPS) and Limited Brands (NYSE:LTD) to that list. At those price multiples, these retailers don't need mammoth sales gains to deliver results to investors. If sales increase just one or two percent more than expected, like we're currently seeing, investors could potentially see some very nice returns.
Investing in retail stocks based on weather forecasts is not a game worth playing. We're all far better off waiting for retail shares to get beaten down to attractive valuations. Shares that are reasonably priced have a margin of safety that protects them from little sales blips. Once the shares are reasonably priced, a successful investor will find companies that have the balance-sheet strength to withstand soft sales, and the free cash flow capacity necessary to repurchase shares and continue raising dividends.
For related retail Foolishness:
- The Yo-Yo of Consumer Sentiment
- Ignore the Retail Doomsayers
- Foolish Forecast: Will Polo's Accessories Match Earnings?
New York & Co. is a Motley Fool Hidden Gems recommendation, and Gap is a Motley Fool Stock Advisor recommendation.
The Motley Fool has kicked off its ninth annual Foolanthropy campaign! Nominate your favorite charities on our Foolanthropy discussion board through Nov. 6. For guidelines on what makes a charity Foolish, visit www.foolanthropy.com .
Nathan Parmelee owns shares in American Eagle Outfitters and New York & Co., but has no financial stake in any of the other companies mentioned. The Motley Fool has an ironclad disclosure policy.
