Retailers That Pass the Guru Test

By
A A A

In baseball lore, few events are as celebrated as Babe Ruth's "called shot". The story goes like this: In the fifth inning of Game 3 of the 1932 World Series, Ruth came to the plate, and, while engaged in some serious back-and-forth jawing with Chicago Cubs players, pointed to Wrigley Field's centerfield bleachers as if to say, "That's where I'm hitting the next pitch." Then, incredibly, he did just that, crushing a home run that gave the Yankees the lead -- and Ruth's legend one of its signature moments.

There's just one small problem: The called-shot story may well be completely false -- over the years, plenty of eyewitnesses, including some of Ruth's teammates, have cast doubt on it. But once one reporter portrayed it that way, others followed, and soon the facts didn't really matter. Many, if not most, baseball fans simply accepted it as true.

That's not uncommon. As human beings, we want to believe in stories. In a world full of unpredictability and chaos, we look to stories to give us understanding, to give us a sense of order. (Barry Ritholtz has a great column on this on The Big Picture blog.) That's all well and good when it comes to a baseball legend. But in the investing world, putting stories ahead of facts is very dangerous. Since the 2008 financial crisis, for example, investors have been giving credence to a number of fear-filled stories. One of the most prominent: the tale of the tapped-out American consumer. According to this story, the housing market crash, stock market implosion, and near-collapse of the entire financial system dealt U.S. consumers a knockout blow in 2008, one from which they wouldn't be able to recover for years, perhaps even decades. Huge declines in consumer spending would mean years of struggle for the economy, and for retail firms in particular.

Like most tall tales, the tapped-out-consumer story was grounded in some truth -- Americans did cut back spending significantly amid the crisis, and they were overleveraged. But amid the fear-filled climate of 2008 and 2009, the tale spun a bit out of control, in part because it provided a great story arc -- after years of overspending and living high on the hog, Americans were getting their comeuppance. Forget Gucci handbags and Prada shoes; citizens of the most powerful country in the world would soon be on the verge of scavenging for food and weaving clothing out of leaves and branches. What drama!

Who knows -- had a few things gone differently, perhaps that scenario would have played out. But it didn't. Consider these facts: While they trended downward from December 2007 to April 2009, real personal consumption expenditures have been on the rebound ever since, and are now 4.7% above that December 2007 peak. Retail sales, meanwhile, are 11.8% above their November 2007 peak. And after climbing above 14% in mid-2007, Americans' collective debt service ratio (the ratio of outstanding mortgage and consumer debt to disposable personal income) has fallen to 10.32% in the fourth quarter of 2012 and 10.49% in this year's first quarter. Those two most recent readings are the lowest the ratio has been at any time since 1980.

Still, the tapped-out-consumer story lingers. And that's good. Because when the story and the facts diverge, opportunities are created. Right now, my Guru Strategies -- which are based on the approaches of some of history's greatest investors -- are finding great value in the retail apparel industry. In fact, it's the top-ranked industry in the market according to my Validea Industry Index, which ranks industries based on a composite of growth and value factors. Here's a look at a handful of apparel retailers that my models think aren't getting enough love -- likely because of the tapped-out-consumer tale.

rue21, inc. ( RUE ): This trendy Pennsylvania-based specialty apparel retailer caters to 11- to 17-year-olds. It recently opened its 700th store in the U.S., operating in 46 states. It has a market cap of about $1 billion.

rue21 gets approval from my Peter Lynch- and James O'Shaughnessy-based models. While the stock's P/E doesn't look cheap -- it's about 24 -- Lynch believed that higher P/Es were merited if the company was growing quickly. And rue21 has been growing earnings per share at a 30.1% pace over the long haul (I use an average of the three-, four-, and five-year EPS growth rates to determine a long-term rate.) That makes for a P/E-to-Growth ratio (a metric Lynch developed) of 0.8, which comes in under this model's 1.0 upper limit -- a sign rue21 is a bargain.

My O'Shaughnessy-based growth model looks for firms that have upped earnings per share in each year of the past five-year period, which rue21 has done. The model also looks for a key combination of variables: a high relative strength, which is a sign the market is embracing the stock, and a low price/sales ratio, which is a sign it hasn't gotten too pricey. Rue21 has a solid 12-month relative strength of 82, and its P/S ratio of just 1.07 comes in well below this model's 1.5 upper limit.

Coach Inc. ( COH ): This New York City-based luxury handbag maker actually wasn't hit too hard during the Great Recession, and it has thrived since then. The $17-billion-market-cap firm is a favorite of my Warren Buffett-based model. It looks for firms with lengthy histories of earnings growth, manageable debt, and high returns on equity (which is a sign of the "durable competitive advantage" Buffett is known to seek). Coach has upped EPS in all but one year of the past decade, has less than $1 million in debt vs. over $1 billion in annual earnings, and has averaged an ROE of 37% over the past ten years, so it makes the grade.

Coach also gets high marks from my Lynch-inspired strategy. For moderate-growth, dividend-paying companies, Lynch added dividend yield to the "G" portion of the PEG ratio. Coach's 16.1 P/E, 2.3% yield, and 17.1% growth rate make for a solid yield-adjusted PEG of 0.83.

The TJX Companies, Inc. ( TJX ): The parent of discount retailers that include Marshalls and T.J. Maxx has done exceptionally well in recent years. The $37-billion-market-cap company has grown EPS in each year of the past decade, one reason it's a favorite of my Buffett-based model. Two more: It has also averaged a 37.5% return on equity over the past decade, and its annual earnings are more than its long-term debt.

My Lynch-based model also likes TJX. The firm's 19.8 P/E and 23.8% long-term growth rate make for a solid 0.83 PEG ratio.

Genesco Inc. ( GCO ): Nashville-based Genesco sells footwear, headwear, sports apparel and accessories in more than 2,455 retail stores throughout the U.S., Canada, the U.K, and Ireland under such names as Journeys, Schuh, Lids, and Johnston & Murphy. The $1.7-billion-market-cap company has taken in more than $2.5 billion in sales over the past year.

Genesco gets high marks from my Lynch model, which loves its 15.9 P/E and 39.9% growth rate, which make for a 0.4 PEG. It also likes the firm's minimal 6.5% debt/equity ratio.

The Men's Wearhouse ( MW ): The Houston-based retailer, which recently acquired Joseph Abboud menswear -- and replaced co-founder and executive chairman George Zimmer -- sells a variety of bargain-priced suits and rents tuxedos. It has a $2 billion market cap.

Men's Wearhouse is another favorite of my Lynch-based model. It's grown EPS at a 21.2% rate over the long haul and has a 14.8 P/E, making for a strong 0.7 PEG. It also has no long-term debt.

I'm long TJX and COH.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: COH , GCO , MW , RUE , TJX

Validea

Validea

More from Validea:

Related Videos

Lies Retailers Tell
Lies Retailers Tell                 

Stocks

Referenced

85%
100%
100%
67%

Most Active by Volume

40,002,232
  • $42.42 ▲ 5.57%
34,741,881
  • $103.663 ▲ 1.16%
23,704,191
  • $8.20 ▲ 0.37%
22,764,217
  • $16.64 ▲ 0.24%
18,328,199
  • $12.505 ▲ 3.95%
18,147,498
  • $79.509 ▲ 1.04%
16,106,199
  • $9.31 ▲ 0.54%
15,582,706
  • $97.08 ▲ 0.22%
As of 10/22/2014, 11:53 AM

Find a Credit Card

Select a credit card product by:
Select an offer:
Search
Data Provided by BankRate.com