This article was published in the March issue of Money magazine.
If Americans have been worrying about the fiscal cliff deal, the payroll tax hike, and another looming budget showdown, they've got a funny way of showing it.
Following a holiday spending binge -- retail sales in December rose at a higher rate than forecast -- consumers are expected to keep on shopping. Forecasts call for sales for the 96 companies in the Standard & Poor's Retail ETF (XRT) to rise nearly 8% on average this year.
The problem for investors hoping to capitalize on the consumer comeback: It hasn't exactly escaped Wall Street's notice. After jumping more than 20% in 2012, the S&P Retail ETF has started 2013 trading near its all-time high -- even though economic growth, while improving, is expected to stay below its long-term average. Yet you can still find values in the retail-stock bargain bin. The key, fund managers say, is to focus on companies that sell the affordable necessities that people will keep buying -- no matter what happens with taxes or the economy.
Think everyday basics
A case in point, says Diane Jaffee, manager of the TCW Relative Large Cap and Dividend Focused funds: Gap (GPS). The retailer, which also owns Banana Republic and Old Navy, has enjoyed a sharp turnaround lately, with same-store sales up 5% over the holidays, compared with a year-over-year drop of 4% in 2011.
Yet Gap still trades at less than 13 times this year's estimated earnings, vs. an average of 17 for other apparel retailers. And Jaffee doubts that consumers will spend less at Gap because of a payroll tax increase. "People don't go to Old Navy or the Gap on impulse," she says. "You go there when you need a relatively inexpensive pair of jeans."
Since GDP growth is unlikely to affect pet owners' proclivity to pamper their pooches and kitties, Brian Lazorishak, manager of the Chase Mid Cap Growth Fund, likes PetSmart (PETM). The industry leader has a history of beating Wall Street's expectations, and analysts recently have raised 2014 forecasts.
Profit from thrift
Price-conscious consumers are also giving a boost to Costco (COST), famous for its low-cost household products and other merchandise, often sold in bulk. Though the stock is a bit more expensive than other retailers, at 20 times estimated 2014 earnings, the valuation is justified by its accelerating growth, says Lazorishak, who is also co-manager of the Chase Growth Fund. Profits are expected to rise nearly 13% annually for the next few years, vs. 10% gains for the past five years.
Related: Tips for investing in stocks
Ross Stores (ROST), which owns the Dress for Less brand, also caters to penny-pinching consumers. Jim Bashaw, who owns the stock in the Ave Maria Growth Fund, notes that its return on equity, a measure of how efficiently a company generates profits, is 47% -- nearly three times the S&P 500 average. Yet the stock trades for just 15 times estimated 2014 earnings. That's a bargain any price-savvy consumer -- or investor -- could love.
Investors are discerning shoppers when it comes to retail stocks.
The clear winners appear to be big-box stores such as Wal-Mart and Target, while specialty outlets such as office supply chain Staples are bringing up the rear.
Shares of Target (TGT) rose to a new 52-week high Wednesday after it reported better-than-expected quarterly earnings and raised its forecast for full-year profits. The stock has gained 26% so far this year, outperforming Wal-Mart's MOREBen Rooney - Aug 15, 2012 2:13 PM ET
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