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3 Top Retail Stocks to Buy in May

Jeremy Bowman, Leo Sun, and Steve Symington, The Motley Fool

Retail stocks are suddenly back in vogue. The industry has been hammered by the rise of e-commerce and Amazon (NASDAQ: AMZN), but after a blowout holiday season many big-box chains have returned to growth, and that turnaround has propelled retail stocks higher.

The SPDR S&P Retail ETF is up 14.2% over the last six months, compared to just a 2.8% gain for the broad-based S&P 500. Investors seem to think that concerns about a "retail apocalypse" are overblown, and with another round of retail earnings coming out this month, the sector could explode once again.

To take advantage of that potential boom, we asked three of our retail writers for their top picks for May. See why they recommend Dollar General (NYSE: DG), Tanger Factory Outlet Centers (NYSE: SKT), and Home Depot (NYSE: HD).

People going up and down escalators inside a mall

Image source: Getty Images.

The biggest dollar-store chain in America

Leo Sun (Dollar General): Times are tough for many brick-and-mortar retailers, but Dollar General, the largest dollar-store chain in the U.S., opened 1,315 stores in 2017, most in rural markets, and finished the year with 14,534 stores. It plans to open another 900 stores this year.

Dollar General sells a wide range of groceries and household goods, most of which cost less than $5. Its comparable-store sales have risen for 28 straight years, so it's clearly holding Amazon and discount superstores like Walmart (NYSE: WMT) at bay.

The discount chain expects its comps to grow in the "mid 2%" range this year. Analysts expect its revenue and earnings per share to rise 9% and 33%, respectively. Those are high growth rates for company with a stock trading at just 16 times this year's earnings.

Its smaller rival Dollar Tree (NASDAQ: DLTR), which also owns Family Dollar, is expected to post just 4% sales growth and 16% earnings growth this year. Yet Dollar Tree stock trades at 17 times this year's earnings. Dollar Tree also doesn't pay a dividend, while Dollar General pays a forward dividend yield of 1.2%.

Dollar General occupies a niche that Amazon and Walmart have struggled to penetrate. Its stores are generally located closer to lower-income areas than Walmart's stores and Amazon's fulfillment centers, and dollar-store shoppers generally aren't keen on premium subscription services like Amazon Prime. Therefore, Dollar General still has plenty of room to run.

A different way to play retail

Steve Symington (Tanger Factory Outlet Centers): As a real estate investment trust (REIT) that focuses on outlet malls across the U.S. and in Canada, Tanger Factory Outlet Centers may not be the first name to come to mind as you're looking for "retail" stocks to buy. But Tanger is uniquely positioned to weather retail-industry headwinds even as many traditional brick-and-mortar retailers fail.

Tanger isn't completely immune to the struggles of its tenants. The stock fell last week after the company reduced its full-year financial guidance, blaming a combination of store closures due to tenant bankruptcies, bad weather in the first quarter, and rent adjustments to help prop up its portfolio occupancy rates (the last of which still stood at a healthy 95.6% at the end of the first quarter).

But Tanger management insists that, on the whole, its outlet centers are continuing to perform well, with relatively consistent traffic and strong sales by the vast majority of its tenants. As it recaptures the square footage related to bankruptcies and brandwide restructurings, it should have little trouble filling that space with other tenants who recognize that outlets -- as CEO Steven Tanger reminded investors earlier this year -- "remain an important and profitable channel of distribution for retailers and manufacturers."

Adding in Tanger's attractive dividend, which boasts an annual yield of 6.6% as of this writing, I think the stock is one of the compelling retail plays our market has to offer.

A smart housing play

Jeremy Bowman (Home Depot): According to some metrics, no high-profile retail stock has done better than Home Depot over the last decade. Shares of the home-improvement retailer have jumped 544% during that period, and it's added more than $160 billion in market value.

Home Depot has benefited from the housing recovery, but the company has also excelled because it's made smart moves. Seeing the tide shifting to e-commerce, management essentially stopped opening new stores ten years ago; instead, it invested in improving its current store base and e-commerce operations, and in returning capital to shareholders. As a result, the company has steadily increased its profit margin, and delivered strong growth to shareholders even while revenue growth has been modest.

The company has also regularly staked out its growth path for investors and knocked down those goals. Management is now calling for compound annual growth from now to 2020 of 4.5% to 6%, which will come almost entirely from the comparable base, and it sees an operating margin of 14.4% to 15%, compared to 14.5% last year. It also expects return on invested capital to rise to more than 40% with the help of the new tax law. Given its commitments to repurchase shares and increase the dividend, earnings per share should increase by double digits on a compound annual basis during that time.

Home Depot will report earnings on May 15; analysts expect earnings per share to jump from $1.67 to $2.06. A strong report could lead to another surge from the home-improvement specialist.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Jeremy Bowman has no position in any of the stocks mentioned. Leo Sun owns shares of Amazon and Tanger Factory Outlet Centers. Steve Symington has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has the following options: short May 2018 $175 calls on Home Depot and long January 2020 $110 calls on Home Depot. The Motley Fool recommends Home Depot and Tanger Factory Outlet Centers. The Motley Fool has a disclosure policy.