How to Pick Winning Retail Stocks, Pt. 1

This column was originally published on RealMoney on June 1, 2007 at 10:00 a.m. ET. It's being republished as a bonus for TheStreet.com University readers. For more information about subscribing to RealMoney, please click here.

I've been following retail stocks for my regular column on RealMoney since November. I'm happy to say that out of the 19 companies I've written about, 17 are in positive territory. Leading the way are:

• Dollar General(DG) (December 2006) with a rise of 37% since I wrote about it;
• GameStop(GME) (January), up 36%;
• Polo Ralph Lauren (RL) (also December 2006), gaining 17%; and
• Yum! Brands(YUM) (February), plus 16%.

Meanwhile, the S&P 500 is up 10% and the Retail HOLDRs(RTH) -- a good proxy for the retail sector -- is up 7.1% since last November.

Of course, not all the picks have worked out. We stopped following January pick Circuit City(CC) after it continued to disappoint. And I'm still waiting for American Eagle Outfitters(AEO), which I wrote about in November 2006, to come around.

Still, on average, things have worked out nicely. I thought it would be worthwhile to take you on a backstage tour and show you my process for picking out a retailer that looks poised for a move up.

Shop What You Know

One of the best ways to begin picking retail stocks is to begin studying retailers that you are familiar with. After all, as shoppers we're some of the best judges of the retail experience, having developed a pretty keen sense of what works and what doesn't.

That means you have to figure out what kind of retailers you might know something about -- apparel? sporting goods? electronics? It's a good idea to have a list of a half-dozen or so potential companies because they won't all make the final cut.

I'll discuss apparel retailers in the next section because I'm interested in them. But if you've read my column before, you know that my interest in retailers is wide and varied. In fact, I like just about any retail platform, from department stores to home improvement to restaurants.

I encourage you to follow suit. Search your interests and find the retailers that excite you and sell products you know something about.