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Investing in Retail Stocks

Updated: June 23, 2021, 1:37 p.m.

Many investors buy retail stocks because it gives them opportunities to own parts of the businesses where they as customers shop every day. But just because you like shopping at a particular store doesn't mean it's a good portfolio investment.

The COVID-19 pandemic benefited some retailers and hurt others. E-commerce sales boomed as consumers avoided stores, and sales of certain products soared. Spending that would otherwise have gone to travel or entertainment instead funded home improvement projects and electronic gadgets.

The economy is now changing since an increasing number of U.S. adults has been vaccinated. Retailers that survived the pandemic are seeing shoppers return, and consumer spending will inevitably shift as the pandemic comes to an end.

Here we delve into some of the top retail stocks and share what you need to know about investing in retail companies.

Top retail stocks

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

1. Amazon

As the preeminent e-commerce retailer, Amazon.com (NASDAQ:AMZN) got its start by selling books and now operates a marketplace that enables the online buying and selling of nearly everything. Amazon's 2017 purchase of Whole Foods Market also gives it a ready-made network of retail brick-and-mortar stores to further engage customers.

Amazon is entering a new era with founder and CEO Jeff Bezos stepping down in July 2021. Only time will tell how the leadership change will affect the company, but Amazon stock is positioned to perform well as consumers continue to shift to online retail.

2. Home Depot

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

Home Depot’s sales soared during the pandemic with a sharp rise in consumers taking on home improvement projects. Strong demand for housing is maintaining high sales volumes even as the pandemic subsides in the U.S. Comparable-store sales increased year-over-year by an astonishing 31% in the first quarter of 2021.

3. lululemon athletica

As a pioneer in athletic clothing, lululemon athletica (NASDAQ:LULU) initially focused on making apparel for yoga practitioners. The company has gradually begun courting a wider set of customers who want to stay fit and dress comfortably.

Store closures due to the pandemic hurt lululemon’s results early in 2020, but the retailer has strongly recovered. Revenue soared by 24% year-over-year in the company’s fourth quarter due to a near-doubling of sales in direct-to-consumer channels. With workers likely to spend less time in the office in the post-pandemic era, demand for lululemon’s products could remain strong at the expense of more formal workwear sales.

4. Ulta Beauty

Tapping into the trend of offering experiences that lure shoppers into stores, Ulta Beauty (NASDAQ:ULTA) 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 were severely impacted by stay-at-home orders last year, and remained weak as 2020 came to a close. Fourth-quarter sales dropped by 4.6% year-over-year as consumers remained wary of in-person shopping. The vaccine rollout is likely to enable Ulta to continue to flourish.

5. Walmart

The biggest retailer in the U.S., Walmart (NYSE:WMT) became famous by offering "always low prices." Despite its many store locations, Walmart understands the importance of also having a strong online presence. The company’s online sales have soared during the pandemic, and its grocery pickup and delivery services are in high demand in the current environment.

The Walmart+ membership program includes free delivery for online grocery orders, which is likely to help the retailer continue to snag new customers. Sales growth has slowed this year, but Walmart continues to both gain market share in the grocery sector and increase its e-commerce business at a blistering pace.

6. Wayfair

The pandemic has been a boon for the online furniture retailer Wayfair (NYSE:W). Despite rapid revenue growth, the company was posting big losses before the pandemic struck. That growth has now accelerated enough to put the company squarely into the black. Wayfair stock has soared as a result, with many investors betting that the good times are here to stay.

Blue Wal-Mart shopping carts stacked together

Image source: Getty Images

Understanding retail stocks

Retail stocks like those described above fall into the consumer discretionary sector, which is composed of companies selling mostly things people want but don't absolutely need. The retail industry includes the following types of businesses:

  • Department stores
  • Clothing stores
  • Stores that sell computers and electronics
  • Home improvement stores
  • Auto parts stores
  • Stores specializing in home furnishings
  • Internet-based companies that sell retail products to people through computers and mobile devices

You're probably familiar with all these types of retailers. One additional category is distributors, which move retail products from the companies that manufacture them to the stores that sell those products to you.

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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 revenues they generate from the products they sell. Retailers can increase sales both by building more stores in new locations and boosting sales at their existing stores.

Same-store sales or comparable-store sales is a retail-specific revenue metric that evaluates revenue growth for stores that have been 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 still not be profitable. Most retailers can lower prices or offer promotions that persuade more people to buy more things, but if their prices are too low, then they lose money on each sale.

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

Performance during key times of the year

Much of the retail business is seasonal, with many retailers doing a large part of their business for the year during the holiday season in November and December. Strong holiday sales can make up 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.

While the end of the calendar year is most commonly the high season for retailers, it's not the only one. For instance, retailers that focus 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 retailer 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, back rooms, and other spaces that 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

Retail companies previously had either physical stores or sold their goods online but 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 are growing much faster than their overall sales. The best retailers use their networks of stores to their advantage by offering services such as in-store pickup and local delivery. Retail businesses without a strong online presence are likely to 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 J.C. Penney and Neiman Marcus were forced to declare bankruptcy, unable to cope with the sudden drop in demand for in-person shopping.

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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