Best Retail Stocks to Buy Now

Many investors buy retail stocks because it allows them to own portions of the businesses where they shop. But just because you like shopping at a particular store doesn't mean it's a good portfolio investment.

To say that it has been a turbulent few years for the retail industry would be an understatement. E-commerce sales boomed during the COVID-19 pandemic as consumers avoided stores, and sales of certain products soared. Retailers battled shortages and supply chain constraints for much of the pandemic as they scrambled to meet consumer demand, and then grappled with inflation spiking to a 40-year high soon after.

But now that the pandemic is in the rear view and inflation has cooled, the retail landscape has somewhat normalized and it could be time to take a closer look. Let's delve into some of the top retail stocks and what you need to know about investing in retail companies.

Four leading retailers

Four publicly traded retailers leading their industries

There are hundreds of publicly traded retailers, but these four have risen to the tops of their industries:

1. Amazon

As the preeminent e-commerce retailer, Amazon (AMZN 0.23%) got started by selling books and now operates a marketplace enabling the online buying and selling of almost everything. Amazon's 2017 purchase of Whole Foods Market also gives it a ready-made network of brick-and-mortar retail stores to further engage customers.

Amazon enjoyed soaring demand during the COVID-19 pandemic as shoppers shifted their spending online, prompting the company to aggressively expand capacity. Now, Amazon is focused on boosting productivity and trimming expenses, and CEO Andy Jassy has made excellent profits, and the bottom line has recovered nicely.

With its immense scale, the online retail giant is well positioned to lead the e-commerce market in the long run. Smaller players without Amazon's scale and logistical muscle have struggled to cope with surging supply chain costs. Plus, Amazon has a highly profitable cloud computing business (AWS) to help shore up the bottom line.

2. Home Depot

The home improvement retailer is best known for its big box warehouse stores and extensive inventory. Serving both do-it-yourself homeowners and professional contractors, Home Depot (HD 1.42%) is consistently expanding both sales and earnings. The company has built a substantial e-commerce presence while largely holding would-be competitors at bay.

Home Depot's sales growth has been sluggish due to slowing consumer spending after years of surging demand for renovation and remodeling projects during the pandemic. Consumers continue to spend on smaller projects, but spending in big-ticket categories is weakening.

Elevated interest rates are a big source of this lull, as they eat away at household spending power and make it difficult to tap into home equity to fund costly projects. But in the long run, the company has plenty of room left to grow within a fragmented industry.

3. Lululemon Athletica

As a pioneer in athletic apparel, Lululemon Athletica (LULU 0.03%) initially focused on making yoga clothing. The company has gradually courted a wider set of customers who want to stay fit and dress comfortably.

Recent results have been strong in a difficult economic climate, with sales growing by 9% year over year in the most recent quarter, including stellar 33% growth internationally. Plus, Lululemon's gross margin and adjusted operating margin expanded by 150 basis points and 70 basis points, respectively.

The popularity of athleisure has staying power, and Lululemon leads the industry. The retailer is on track to reach its goal of annual sales of $12.5 billion by 2026 and to grow even further from there. This growth will be driven by increasing sales of men's clothing, doubling down on direct-to-consumer sales, and continuing its impressive international expansion.

While a tough economy could push back Lululemon's growth plans, the retailer has so far been largely unscathed by high inflation, rising interest rates, and growing caution among consumers. That's a testament to the company's powerful brand.

4. Ulta Beauty

Tapping into the trend of providing experiences that lure shoppers into stores, Ulta Beauty (ULTA 1.07%) offers in-store salon treatments to its customers. The concept has taken off, and its stores were attracting plenty of customers before the pandemic struck.

Ulta's sales continue to be strong in a tough environment for discretionary spending, with net sales up by about 2% year over year in the latest quarter. Most of the growth was fueled by new stores, and comparable sales were roughly flat.

Total revenue should top $11 billion in 2024, based on the company's guidance, and an operating margin in the mid-teens is a testament to how well the Ulta model works. A recession would likely hurt sales and profits in the short term, but Ulta's long-term growth prospects are very much intact.

With all of that in mind, Ulta could be in a great position to thrive as inflation continues to cool and interest rates come down. Management seems to think the stock is a bargain and anticipates about $1 billion in share repurchases this year alone.

Identifying top retail stocks

How to identify the best retail stocks

Finding high-quality retail companies requires looking at some key aspects of the company's retail business. The strongest retailers perform well based on these key metrics:

Sales growth

The best retail companies consistently expand the revenue they generate from the products they sell. Retailers can increase sales both by building more stores in new locations and by boosting sales at existing stores.

Same-store sales, or comparable-store sales, is a retail-specific revenue metric that evaluates revenue growth for stores in business for at least a year. The best retailers produce strong same-store sales numbers and robust overall sales growth.

Earnings growth

A retailer can generate revenue but remain unprofitable. Most retailers can lower prices or offer promotions that persuade more people to buy more things, but if their prices are too low, they lose money on each sale.

The top retail companies have loyal customers willing to pay premium prices, and these companies can also minimize costs to maximize profits. Investors should be cautious about buying shares in retailers that struggle to increase their earnings as measured by absolute values and earnings per share.

Performance during key times of the year

Much of the retail business is seasonal, and many retailers do a large part of their annual business during the holiday season in November and December. Strong holiday sales can compensate for weaker business conditions at other times of the year. Many retailers also offer lucrative promotions to shoppers during the holidays to further boost their seasonal sales.

Although the end of the calendar year is most commonly the high season for retailers, it's not the only one. For instance, retailers focused on younger shoppers typically see big spikes in sales during the back-to-school season.

Examining sales trends can help you understand the degree to which a retail business is seasonal. Strong performance by a retailer during a key season can indicate that the company is outcompeting its rivals.

Size of store network and real estate holdings

In addition to knowing a retailer's number of stores and its locations, investors can pay attention to retailers' real estate holdings. Retailers that maintain networks of physical stores may have extensive real estate assets.

While maintaining and improving stores can be costly, the retail floor, backrooms, and other spaces retailers own or lease have value. Even when a company's retail operations aren't particularly profitable, the value of its underlying real estate can comprise a huge portion of the company's overall worth.

Investors can also evaluate how efficiently a retail company uses its real estate. Computing metrics such as sales per square foot can indicate how profitably a retailer leverages the space it owns to sell its products.

Strength of e-commerce sales

Previously, retail companies either had physical stores or sold their goods online, rarely both. Today, many companies have both e-commerce portals and brick-and-mortar locations.

As e-commerce has increasingly gained popularity, many retailers' online sales have grown much faster than their overall sales. The best retailers use their network of stores to their advantage by offering services such as in-store pickup and local delivery. Retail businesses without a strong online presence will likely have increasing difficulty competing with their peers.

Balance sheet strength

When considering investing in a retailer, look for plenty of cash and manageable debt on its balance sheet. The pandemic caused steep sales declines and big losses for portions of the retail sector, and retail businesses that were financially fragile before the crisis have not fared well. Major retailers, such as JCPenney and Neiman Marcus, were forced to declare bankruptcy, unable to cope with the sudden drop in demand for in-person shopping.

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Are retail stocks right for you?

Are retail stocks right for you?

It's always fun to invest in companies you know and love, and retail stocks often fit the bill. Focus on the retailers with the strongest business fundamentals -- low debt levels, healthy cash flows, and strong competitive positions -- to give yourself the best chance to make money for your investment portfolio.

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