Daily Gains Letter

My Favorite Pick in the Retail Sector Is Not What You’d Think

By for Daily Gains Letter |

Variables Aligning for Retail to Outperform 2013The retail sector can return some amazing gains as we have witnessed since the recession ended—but it can also provide periods of anxiety.

How the retail sector performs is dependent on many variables, including the economy, jobs, housing, consumer confidence, interest rates, and even the weather, as we witnessed this winter.

There is no tried-and-tested rule on what areas of the retail sector do well. For instance, if you think discount and big-box stores always fare the best, while high-end luxury-brand stocks underperform during times of economic uncertainty, then you are likely off the mark.

The reality is that the past years of massive wealth creation in the stock market and a rebounding housing market have helped to create wealth, and with this comes the desire to spend. There have been some 300,000 new millionaires created in the country in 2013, and that means a propensity to want to spend specifically on higher-end goods and services.

The rationale supports why luxury stocks, such as Michael Kors Holdings Limited (NYSE/KORS) and Tiffany & Co. (NYSE/TIF), have done so well over the past few years. In the luxury retail sector space, Michael Kors continues to be one of my favorite retail sector stocks.

KORS Michael Kors Holding Ltd Chart Chart courtesy of www.StockCharts.com

Meanwhile, the bottom end of the retail sector, which includes the discount and big-box stores, has provided mixed results; albeit, these stocks have made investors a lot of money.

One of my favorite discount stocks in the retail sector is Family Dollar Stores, Inc. (NYSE/FDO). But the company recently reported a soft fiscal second quarter, in which same-store sales fell 3.8% in the quarter; year-over-year, sales in the quarter fell by more than six percent. Moreover, the company reported a massive shortfall in earnings after reporting a disappointing $0.80 per diluted share, way below the $1.21 per diluted share recorded in the past year. The weather’s impact accounted for only about $0.05 per diluted share, so you know the numbers are bad.

FDO Family Stores Chart Chart courtesy of www.StockCharts.com

For Family Dollar Stores to report such a big miss is worrisome. The company already announced it would close about 370 underperforming stores and slow down its new store expansion. While the results are suggestive of weakness, I continue to like the stock, especially on the current price weakness. Potential investors can accumulate on additional weakness.

If the economy and jobs creation continue to grow modestly, we could see the retail sector grow more this year than in 2013. Retail sales (excluding auto and food) could grow 4.1% this year versus the approximate 3.7% in 2013, according to the National Retail Federation. (Source: “NRF Forecasts 4.1% Increase in Retail Sales for 2014,” National Retail Federation web site, February 6, 2014.) The estimate assumes gross domestic product (GDP) growth of between 2.6% and three percent for the year, monthly average jobs growth of 185,000, and improvement in the housing market.

If the numbers come close to the NRF’s estimates, we could see a decent year for the retail sector; albeit, you need to be selective in what stocks you add.

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