Tech-Free Friday: Buying the Retail Story

Peter Lynch had a thing for retail investing. His mantra was quite simple: If you like the store, chances are you may like the stock.

It may not be as easy as that, but his motto is a good starting point for tech-weary investors browsing for stocks in the retail sector.

While the bottom has fallen from much of the market and worries about a recession continue to haunt the national psyche, retail stocks have made plenty of money for investors since mid-October and significantly outperformed the broader market. During that time, the S&P Retail Index is up around 20%, even with losses it has taken in recent days amidst the general tech-led market meltdown.

And while by some yardsticks certain retail stocks appear expensive, there are plenty of opportunities for the savvy stock picker, say analysts.

Let's Go, Aggies

"While we recognize that picking a good retail stock might be just as difficult as picking the winner of the NCAA's March college basketball tournament, we continue to recommend the teams that have shown the most consistency throughout the entire season," wrote Lehman Brothers analyst Jeffrey Feiner in a recent note, "March Madness: Retail Stocks or NCAA B-ball?"

He picks Stanford to take the hoop title, and offers investors four top discount-oriented retailers: Wal-Mart (WMT), Target (TGT), Costco (COST) and Kohl's (KSS). All four, he says, are off their 52-week highs and are well-positioned to see their sales hold up in a faltering economy. (Feiner has strong buy ratings on all four stocks, and his firm has had underwriting relationships in the past with the four companies.)

Retail Pricing Checking out some retail stocks
Company	P/E*	EPS Growth**	Percent Off High***
Kohl's (KSS:NYSE)	47	24%	8%
Target (TGT:NYSE)	20	15	4
Wal-Mart (WMT:NYSE)	30	15	23
Lowe's (LOW:NYSE)	24	20	10
Home Depot (HD:NYSE)	33	21	38
Best Buy (BBY:NYSE)	24.3	22	50
Costco (COST:Nasdaq)	23	15	37
Source: First Call/Thomson Financial. *Forward earnings estimates. **Five-year average. ***Percentage off 52-week high.

"We believe Americans' increasing price-consciousness will continue to favor value-oriented retailers, especially in the current sluggish economic environment," Feiner says. These types of discounters, says Feiner, have gained 15% to 18% of market share over the past five years, while traditional department stores have lost 10%. Feiner acknowledges that the valuations of these four could be considered high -- they range from 20 times forward earnings for Target to about 47 times for Kohl's -- but he thinks they have room to appreciate. He points to visible and predictable earnings growth -- the very thing tech companies lack.

"Despite somewhat high valuations, we continue to believe that the shares of select growth and value-oriented retail equities continue to offer favorable risk/reward profiles," he says.

Mr. Fixit

Two other companies worth taking a look at are home improvement retailers Lowe's (LOW) and Home Depot (HD), says David Brady, a former retail analyst and manager of the $1.3 billion Stein Row Young Investor fund. Retailers are historically among the top-performing sectors in the wake of Federal Reserve interest rate cuts, and both of these companies' fortunes are very closely tied to the direction of borrowing costs. (Stein Rowe holds positions in Home Depot.)

"I think both companies are very well-managed," Brady says. "Both are well-positioned to benefit from a declining rate environment. When the Fed cuts again, mortgage rates will come down and people will buy homes."

Since Jan. 3, the Fed has twice slashed rates, by a half-percentage point each time. It is considered a foregone conclusion the Fed will continue to cut rates in its effort to rescue the economy from recession.

Lowe's is also a favorite of Merrill Lynch analyst Peter Caruso. He says the company has managed its earnings much better than Home Depot and has one of the best logistics infrastructures in retail. These factors -- plus aggressive plans to open stores in underserved markets -- have Caruso ignoring the relatively high valuation of the company. "Despite the stock's run this year [up around 39% year to date], we believe all the factors needed to push this valuation to a higher level are beginning to come together," he says. (Caruso has a strong buy on Lowe's, and Merrill Lynch has had a banking relationship with the company.)

Want one more pick?

Try electronics retailer Best Buy (BBY), which, although it has been one of the top-performing stocks of the year among retailers, is still relatively inexpensive compared with its rival, Circuit City (CC), says Caruso. Of 30 major retailers Caruso examined, Best Buy ranked 27th least expensive, even though its share price is up 55% on the year. And its sales metrics outpace Circuit City's. For example, Best Buy saw a 6.4% gain in sales per average store in the fourth quarter, vs. a 1.7% decline for Circuit City. (Caruso has a strong buy on the stock, and Merrill Lynch has had a past underwriting relationship with Best Buy.)

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