Analyzing Retail Stocks

These 9 simple steps help investors evaluate retail companies

For an industry that's supposed to make shopping easy, retailers can sure make analyzing retail stocks hard. The good news is, despite the sector's surplus of investing metrics, the task gets easier once you know which ones really matter. Here's a nine-point checklist for sizing up a retail stock.

Key Takeaways

  • While retail companies can be challenging to analyze as investment opportunities, there are several key metrics that can make the process easier.
  • Investors can visit the physical and online store locations, analyze promotional activities, examine gross margin trends, and review sales-per-square-foot data.
  • Other good metrics an investor can review include inventory/receivable trends, same-store sales, price-to-earnings ratios, and tangible book values.

1. Visit the Stores

An investor can learn a lot by getting out from behind the desk and into the shopping aisles. A store's layout, the availability and appearance of merchandise, and the prices charged can provide crucial information about a retailer that can't be gleaned from a balance sheet. Like shoppers, investors favor well-lit stores with fashionable merchandise attractively displayed. Unlike consumers, they hate to see so much good stuff it must be discounted.

A savvy investor will also note the foot traffic. Is the store crowded? Are there lines at the registers? Are shoppers buying big-ticket items in bulk or hovering around the discount racks? Not least, how does what one sees stack up against the consensus view of the company's health embedded in the share price, as best as that can be determined?

If the company has a strong online presence or is strictly an online retailer, perform the same due diligence on its e-commerce site. "Walk" the virtual aisles. Note the appeal of the web layout, the prices, the ease of the check-out process, and the quality of customer service. Find third-party reviews online.

2. Analyze Promotional Activities

Is the company cutting prices and running sales to unload overstocked merchandise? Or is the lack of promotional activity the result of inadequate inventory that's costing it sales? A retailer's pricing trends can be an important leading indicator for investors.

Visiting stores and examining weekly circulars or online ads can help uncover any undue discounting likely to hit margins and earnings.

3. Examine Gross Margin Trends

Investors want to see sequential and year-over-year growth in gross margins, keeping seasonality effects in mind. Most retailers see a sales surge in the fourth calendar quarter amid the holiday shopping season. In any case, gross margin trends will give the investor a better idea of how profitability is evolving and what the market's expectations might be in that regard for the near future.

Investors should be wary of retailers registering a decline in gross margins, either sequentially, holiday seasonality aside, or year-over-year. Those companies may be experiencing a decline in revenue or foot traffic, an increase in product costs, and/or heavy markdowns of merchandise.

4. Focus on Sales-Per-Square-Foot Data

This metric, revealed by some companies in conference calls and others in their 10-K or 10-Q filings, is a reliable indicator of how efficiently management is using its stores and allocating resources. The higher the sales-per-square-foot the better, when comparing direct competitors with similar businesses.

Keep in mind that the number will vary widely depending on the retailer's market niche. For its fiscal year 2021 ended Jan. 29, 2022, Target (TGT) reported sales-per-square-foot of $437, while Lululemon Athletica Inc. (LULU) had sales of $1,443 per square foot in its fiscal 2021 ended Jan. 30, 2022. That's not surprising considering Target sells moderately priced goods out of enormous super-centers, including men's sweatpants for about $20, compared with about $108 for lower-end full-price ones at Lululemon's online store. It makes more sense to compare Target's sales per square foot to its own $388 in sales per square foot the prior fiscal year, or to the $535 in sales per square foot for Walmart Inc. (WMT) in its fiscal year 2022 ended Jan. 31, 2022.

5. Examine Inventory/Receivable Trends

Investors should examine sequential and year-over-year trends in both inventories and accounts receivable (AR). If all is well, these two accounts should be growing on pace with revenue. However, if inventories are growing faster than revenue, it could indicate a retailer's merchandising strategy isn't working. When this happens, companies are left with an unappealing choice between discounting the overstocked product or writing off the merchandise altogether. Earnings would suffer in either case.

If receivables are growing faster than revenue, this may indicate the company is not getting paid on a timely basis and faces a sales slowdown in the future. In short, changes in the inventory and receivable accounts should be closely monitored, as they can anticipate the trend in revenue and earnings.

6. Examine Same-Store Sales Data Closely

This is the most important metric in retail sales analysis. Same-store sales measure sales in a retail chain's stores open at least a year compared to sales at the same stores a year, a quarter, or a month earlier. By excluding the sales added by the new stores opened since the comparison period, same-store sales better illustrate trends at established stores, controlling for the growth from expansion in the number of outlets.

Investors want to see strong same-store sales growth, whether from quarter to quarter or year to year. That suggests that revenue growth is not dependent on a rapid pace of new store openings that's unlikely to be sustainable.

7. Calculate and Compare P/E Ratios vs. Expected Earnings Growth Rates

An investor evaluating retailers should calculate a company's current price-to-earnings ratio (P/E ratio) and compare it with the company's expected rate of earnings growth. Companies trading at an earnings multiple below the expected growth rate may warrant further research.

Other, less quantifiable factors, from the quality of management to the state of current market expectations, are likely to matter more to future returns, making P/E ratios and projected growth rates mostly useful as initial screening criteria.

8. Tabulate Tangible Book Value

A company's tangible book value per share shows what its assets are worth and what investors are getting for their money. To determine this number, investors should take the total "stockholder equity" number from the company's balance sheet and then subtract any intangibles such as goodwill, licenses, brand recognition or other assets that can't be readily defined or valued. The resulting number should then be divided by the total number of outstanding shares. Or you could just plug the stock's ticker into an online calculator like the one from FinBox. Companies trading at or near tangible book value per share may be attractively valued.

9. Examine the Geographic Footprint

All other factors being equal, invest in the retail chain better diversified geographically. Consider the case of the pharmacy chain Duane Reade, which in 2010 became a subsidiary of the Walgreens Boots Alliance (WBA). In 2001, Duane Reade had a huge presence in New York City, and its sales suffered in the wake of the Sept. 11 terrorist attacks. Rival Walgreens was less concentrated in a single metro area, and its sales were affected less.

The Bottom Line

To analyze a retail stock, investors need to know how the chain's stores look and feel, what the market expectations are of the company, and how the chain is performing based on the metrics that matter most to institutional traders. Or you could buy a broad market ETF and go fishing.

Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
  1. Target Corp. "Target Corp. Form 8-K, May 17, 2022," Page 3-4.

  2. Target Corp. "2021 Financials: Financial Summary."

  3. Lululemon Athletica, Inc. "Form 10-K for Fiscal Year Ended Jan. 30, 2022," Page 3.

  4. Walmart. "Walmart Form 10-K (FY22)." Page 38.

  5. Walgreens Boots Alliance. "History."

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