Retail Stocks: Buy or Beware?

Jeff Macke

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Black Friday is the biggest day of the year for retailers but today was much more important for those considering retail stocks. The release of October retail sales from the government and earnings reports from 2 of the biggest merchants in the world marked the peak of the data deluge making this a perfect time to sift through the numbers and see what we've learned.

The data has been surprisingly strong given the dour reports about the mood of consumers. As my partner Matt Nesto pointed out, the 0.6% ex-autos retail sales growth reported for October was the best since last March. Even better, Nesto notes that the figure was 0.7%, ex-autos and gas, and up 7.4% from last year. The numbers were stellar, but Nesto, like many investors, dismisses them as a "data diversion" taking our tired eyes off of Europe and the government's next carnival of ineptitude: The Super Committee set for later this month.

Our focus on retail stocks brought out Nesto's inner Grinch. But let's breakdown stock performance numbers.

Over the last 3-months retailers have been the best of the 24 sectors in the S&P 500. Within the Dow Jones Industrial Average's 30 components, Home Depot's (HD) performance tops them all with a greater than 20% 90-day return, and Wal-Mart (WMT) comes it 4th at 18%. Both reported third-quarter earnings this morning with WMT coming in a penny light but raising the guidance range, and Home Depot scoring the trifecta of an earnings beat, a guidance raise, and a hiked dividend.

The data is strong but Nesto says investors should be using the news to lock in gains. "Who out there is not already long the 'lean inventory, wide margin' story?" he gripes. "We do have to worry about Europe and the Super Committee!"

In my opinion, the pullback we're seeing today was expected and should be bought. Black Friday isn't going to get canceled when the Super Committee misses its November 23rd fake deadline. Americans aren't going to cancel Christmas because of the yield on a Spanish 10-year and Europe produces little to none of the goods lining the shelves of Home Depot, Wal-Mart or Target (TGT).

Europe will still be around in January and if we learned one thing from the August debt ceiling debate it's that paying attention to the inner workings of DC politics is pointless and depressing. Consumers simply don't care about such things this time of year.

Retail stocks have been strong because they're hypersensitive to the economy which has been slightly better than seemed likely last August. Forget HD and WMT and take a look at the quarter Dick's Sporting Goods (DKS) just posted. When the economy is sour you can easily have a catch in the empty aisles of Dick's. Today the company beat earnings, raised guidance, and instated a dividend. The stock is higher and seemingly oblivious to macro concerns.

Unlike Dick's, most retail stocks are likely to take a well-deserved breather when they report. That's a good thing. Consolidating gains is what strong stocks do. I already own Costco (COST) and Ralph Lauren (RL) in my portfolio and all I want for Christmas is a good entry point on quality retail names.

Note to Santa: I've been very good.

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