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Beating the Street: Insights Into Retail Stocks

Although retail is no longer a glamorous sector for many investors, when Peter Lynch wrote "Beating the Street" in 1993, it was hot. For example, he told us that if we had invested $10,000 each in Home Depot (NYSE:HD), Limited, Gap (NYSE:GPS) and Walmart (NYSE:WMT) in 1986, that $40,000 would have been worth more than $500,000 just five years later.

In typical Lynch fashion, the author led into his discussion of retail stocks by describing a trip to a major shopping mall. Along the way, he passed two Radio Shack stores, Taco Bell (now part of Yum Brands (NYSE:YUM)) and several other stores whose companies had stocks posting outstanding gains. Once in the mall, there were many more stores representing companies in which he had taken a position.


Readers of his earlier book, "One Up on Wall Street," will recall that Lynch, the manager of the Fidelity Magellan Fund between 1977 and 1990, liked to find popular stores, jammed with lots of loyal customers, and then check the financial attractiveness of their stocks. This trip was no exception, as he wrote:


"That the Burlington Mall lacks a brokerage office is too bad, because otherwise it would be possible to sit here all day and check the traffic in and out of the various stores, then shuffle down to the broker to put in buy orders on the ones that are the most crowded. This technique is far from foolproof, but I'd put it far ahead of buying stocks because Uncle Harry likes them, which brings us to Peter's Principle #14:

If you like the store, chances are you'll love the stock."



Lynch conceded he had been a fan of retailers since finding Levitz Furniture, which rose 100-fold, and then "folded" in a less positive way in 2008 (long after he left the investment business in 1990). He also liked retailers because it was easy to monitor their progress, both as a popular store and as a regional chain. Once it had proved itself regionally and began to expand into the rest of the country, it was an investor's dream.

He pointed out employees of stores in malls have an "insider's edge" because they can see how their stores are doing, as well as get helpful scuttlebutt from colleagues in other stores. But managers of malls have the biggest edge since they see the monthly sales figures on which rents are based. He added, "The Lynch family has no relatives who are mall operators, otherwise I'd be inviting them over for dinner three or four times a week. But we do have shoppers, which is the next best thing."

Lynch's children led him to a couple of stocks that he failed to follow up on: Clearly Canadian (CCBEF), a carbonated water drink (of which there were many bottles in their home's refrigerator) and Chili's restaurants, which are owned by Brinker International (NYSE:EAT).

Just before Christmas one year, he took his three girls to the mall so they could shop, and he could see what interested them. On that trip he expected them to first go to the Gap, but they surprised him by going to the Body Shop instead, a store that sold lotions and bath oils based on fruit and berries. It was one of the three busiest stores in this very large mall.

Lynch was surprised when he got back to his office and checked out the chain--it turned out he had already bought a small holding, put it on his "tune-in-later" list, and promptly forgot it (in fairness, he held 1,400 stocks at the time). It began trading at about 10 cents a share in 1984 and increased 70-fold in the next six years.

Buying more, much more, stock was foremost in Lynch's mind, but he was put off by its high price-earnings ratio of 42. To deal with this type of situation, he had this recommendation: "The best way to handle a situation in which you love the company but not the current price is to make a small commitment and then increase it in the next sell-off."

Moving on to another issue, can companies that make major gains, say 10- or 20-fold increases, continue to keep growing? Lynch had an emphatic "yes" to that question. First, discussing Walmart, he ruled out greed as a factor, writing, "A stock doesn't care who owns it, and questions of greed are best resolved in church or in the psychiatrist's office, not in the retirement account."

In 1980, a decade after it went public, Walmart's stock price was up 20-fold and some investors thought that was all it would manage. However, Lynch saw that there were stores in only 15% of the country, which meant a lot of potential growth (he didn't even discuss international expansion).

Second, he tried to frame the issue appropriately. He wrote, "The important issue to analyze was not whether Wal-Mart stock would punish the greed of its shareholders, but whether the company had saturated its market." Following up on that point, he added:


"In a retail company or a restaurant chain, the growth that propels earnings and the stock price comes mainly from expansion. As long as the same-store sales are on the increase (these numbers are shown in annual and quarterly reports), the company is not crippled by excessive debt, and it is following its expansion plans as described to shareholders in its reports, it usually pays to stick with the stock."



Conclusion

In chapter eight of "Beating the Street," Lynch focused his thoughts on finding and buying retail stocks. Although retail is no longer the giant it was in his active investing days, it still remains a field of opportunities, especially among the quality companies.

The first half of the chapter buttressed a point made forcefully in "One Up on Wall Street," that busy stores make good investment candidates. In the second half, he addressed the idea that big gains do not preclude further gains--as he pointed out, as long ago as 1980, some investors thought Walmart was too big to grow any further.

Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.

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This article first appeared on GuruFocus.