Why Buy Retail Stocks?

As investors hunt for bargain stocks with strong growth potential, many are taking a closer look at retail stocks – and for a good reason.

As of October, U.S. retail stocks have rallied hard, despite the sharp curb on consumer spending. The top retailing shares have improved upwards approximately 103%, according to a recent report by Capital IQ. In fact, they have advanced far more than the S&P 500, which climbed 17% during the same period.

Ann Taylor, Dillard’s and Pacific Sunwear were among those retailers with increases of 200% and above. Kirkland’s, the home décor store featuring framed art, mirrors, wall décor, candles and lamps, saw its stock jumped 438%.

Among Capital IQ’s total list of 111 major US retailing companies, only six stocks were in the negative at the end of the third quarter.

Experts say certain retail stocks will continue to see positive movement next year as long as consumer spending continues to improve. Companies that can figure out what people really want will see the most gains in their stock prices.

The stores most likely to pull ahead of the pack in 2010 will be those with earnings and sales that exceed analysts’ expectations, according to Bob Keiser, senior director with the Market, Credit and Risk Strategies group at Standard & Poor’s.

Investors should pay close attention to how retailers do in this fourth quarter, which will include sales from their three busiest shopping seasons — Halloween, Thanksgiving and Christmas. “There is a limited pool of consumer dollars out there. It’s going to be a very competitive, feeding frenzy to grab a large portion of those dollars,” says Keiser.
A number of retailers sent strong signals that they are on the right track.  Aeropostale (ARO), American Eagle Outfitters, Gymboree and others raised their quarterly profit forecasts. TJX Companies–whose message of value helped to boost it shares up 80% and made it one of the best performers in the downturn–saw even more shoppers visit its stores in September.

Most analysts say that picking profitable retail stocks for 2010 will be more challenging. “In 2009 you could close your eyes and pick any retail stock. There was more growth opportunity because stocks were so heavily discounted. Now more traditional analysis has to be done to show how the growth unfolds and how much market share they have,” says Timothy Fidler, senior vice-president, portfolio management, Ariel Capital Management.