Four Stocks Peter Lynch Would Like

Before you turn up your nose at the idea of buying a retailer of used games, consider this: Used games sell for a higher profit margin than new games. That has helped GameStop increase operating profit by 2.4 percentage points in the fiscal year that ended in January 2003. Thanks to its 1996 bankruptcy reorganization, the company carries almost no debt and showed $3 a share in cash at the end of 2002. Cash flow is positive, and the company is buying back shares. In the conference call after its May 21 earnings report, the company projected earnings per share of $1.03 to $1.06 for the fiscal year that ends in January 2004.

Longs Drug Stores

In a substitution economy, I expect consumers will try to curb impulse buying. But I don't expect them to succeed very well, despite their best intentions. The attempt, though, will shift where impulse buying takes place. In a slow-growth economy, the buying will likely occur in a store that consumers enter to buy necessities.

The humble drugstores, the place most consumers have to go to get prescriptions filled, should reap a disproportionate share of that impulse buying, and no drugstore chain is better set up to snare those impulse dollars than Longs Drug Stores (LDG). The company's stores are larger than those of CVS (CVS) and Walgreen (WAG), and managers already have the power to customize inventory to local tastes. That produces higher-than-average per-store sales of high-margin items such as cosmetics and greeting cards. The stock trades at 17 times projected 2003 earnings per share.

The more substitution stocks to study like these come out of your own experience, the less likely this kind of analysis will feel fuzzy to you. For example, I've personally spent a lot of time shopping for games, so I know the retail choices frustratingly well, and I've spent more hours than I care to admit in our local GameStop with my son. I feel I have a Lynchian personal understanding of this part of the consumer market that makes me confident enough to add GameStop to Jubak's Picks.

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