Retail Stocks Are for Suckers: Why Their Rally Won't Last

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TargetWhat is going on with the stock market these days? The Dow Jones Industrial Average is on a tear, up something like 6% so far this year. If it keeps on going at this rate, we'll wind up going into 2013 at Dow 18,000.

Wildfire success like we've seen in the stock markets lately has a lot of folks throwing caution to the wind, and looking for ways to get a piece of the action, to not get left out of a stock market on steroids. As one professional talking head recently told The Wall Street Journal, "the decline in market volatility" means it's time to take "a more aggressive approach for the calmer market ... picking more economically sensitive companies, such as ... retail stocks."

Sorry, Charlie. Retail stocks are for suckers. Here's why:

Retailers in the Discount Bin

On the one hand, it's understandable that investors might be attracted to retail today. A lot of these stocks got hit hard in 2011, and that has a lot of folks thinking they must be cheap. Over the past year, shares of Target (TGT), for example, have lagged the S&P 500's performance by a good 5%. Kohl's (KSS) is down 5% in absolute terms, and Sears Holdings (SHLD) has lost a whopping 45% of its market cap.
More recently, though, shares of these three companies have been outpacing the rest of the market pretty handily. Kohl's and Target are both up nearly 10% from the beginning of 2012, while Sears has rocketed up 65% from where it ended 2012.

So if retail stocks are starting to join in the rally, but they're still significantly cheaper than they were a year ago, that must mean you should buy them, right?

Wrong. Here's how retail stocks average, price-wise, across a small variety of subsets from the group:

Segment

Average P/E

Examples

Apparel stores

16.9

American Eagle Outfitters, Abercrombie & Fitch

Sporting goods

21.9

Dick's Sporting Goods, Foot Locker

Department stores

22.4

Kohl's, J.C. Penney

Discount stores

22.8

Walmart, Target



Mind you, I'm not saying there are no bargains to be found anywhere in retail. Within each category, individual stocks may be either more or less expensive than the average. (They may also be absurdly overvalued, as is the case with stock "star" Sears -- up 65% in a month, but entirely devoid of profit.) But as a general rule, within each subset and throughout the industry in general, retail stocks cost significantly more than your average stock on the S&P 500, where trailing P/Es hew closer to 15.1.
And don't even get me started on the "e-tailers." Blue Nile (NILE) at 48 times earnings? Amazon.com (AMZN) at 136 times? Crazy overpriced.

Growing, Growing, Gone!

Now, most investors know that you can't view P/E in a vacuum. A high-P/E stock may still be a bargain if its growth rate is good enough, and according to most analysts, growth prospects for retail look pretty good. On average, analyst estimates tell us that most retail companies should grow their earnings at about 14% per year over the next five years.
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That prediction may turn out to be optimistic.

A couple of weeks back, the Bureau of Economic Analysis released its fourth quarter 2011 GDP report showing consumer spending rising "sharply" for the second quarter in a row. You have to assume this report had something to do with the sudden optimism about retailers. But here's the thing: Even if the data are right, and even if consumers are spending more right now, they won't be able to keep it up for long.

According to the number crunchers at the Consumer Metrics Institute, there's something strange about the sudden spike in consumer spending last quarter. Consumers' "disposable income was flat, indicating that some of that improvement ... may simply be retail sales brought forward as a consequence of deep holiday discounting on the part of retailers." Moreover, CMI warns that in the absence of wage growth, "the fourth quarter splurge on goods is likely coming from a draw-down in savings."
But as anyone who's ever overdrawn a checking account (and been dinged with a bank fee) knows, savings eventually run out.

(The old joke springs to mind: "What do you mean I'm out of money?! I've still got checks right here in my checkbook.")

Suckers Rally

And here's the real moral of the story: Even if consumers still have checks, they may not have much money left to continue shopping. If and when their wallets run dry, so too will the rally in retail stocks.
Anyone who buys into the retail stock rally without considering this risk is getting played for a sucker.

Motley Fool contributor Rich Smith does not believe in the rally. And he doesn't own shares of any company mentioned above. The Motley Fool owns shares of Amazon.com, Walmart Stores, and Dick's Sporting Goods. Motley Fool newsletter services have recommended buying shares of Amazon.com, Blue Nile, and Walmart Stores and have recommended creating a diagonal call position in Walmart Stores.



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