Let This Top Dog Run Your Portfolio

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Peter Lynch is famous for urging investors to look for great companies by reviewing the products they or their family members use every day. Lynch's strategy is easy when you can't stop thinking about how great your newest tech gadget is, or your spouse won't stop talking about how great a new clothing designer makes her look. But what about those family members who can't vocalize their excitement? If you're one of the 62% of Americans who have a household pet, you may be missing a great investment opportunity begging for your attention.

A $50 billion industry
Total U.S. pet-industry spending was estimated to top $50 billion in 2011 and has been growing almost 6% every year since 2001. Owning a company like Procter & Gamble (NYS: PG) or Colgate-Palmolive (NYS: CL) can give you exposure to the industry. One of Procter's 24 billion-dollar brands is Iams pet food. Colgate's pet-nutrition segment accounted for 13% of the company's worldwide sales in 2011. But these companies are huge, and the pet segments account for only a small amount of total revenue.

A purebred
The pet industry has a lot of mutts running around. It's extremely fragmented, with dozens of small shops and groomers available in just about any town. Only two national pet stores effectively dominate in the industry: PetSmart (NAS: PETM) and privately held Petco. While both companies will continue to benefit from the trend of "humanizing" our pets, and even if you could invest in both, PetSmart is positioned to realize greater returns. With a 70% larger footprint, PetSmart has more room for products and high-margin services while still having a 10% price discount to Petco. The price discount is one of the biggest advantages PetSmart has over its closest rival, and that should continue into the future. Petco is still licking its wounds from its 2006 leveraged buyout, which strapped the company with a huge debt burden. Knowing Petco has a price floor and growth limitations because of debt, PetSmart can change its pricing strategies in competitive locations to gain a greater percentage of the market.

Outsmarting the handler
PetSmart recently announced fourth-quarter earnings and beat analyst estimates across the board. The retailer earned $102 million, or $0.91 per share, above the $0.90 the Street was expecting. Revenue was $1.64 billion, beating the $1.62 billion prediction. PetSmart is now forecasting earnings for 2012 at a range of $3.02 to $3.16 per share, leaving outsiders' estimates of $2.54 per share in the dust.

Small dog in a big park
Over the next five years, PetSmart is expected to grow its bottom line by 16% annually, compared with 13% at Costco (NAS: COST) , 11% at Target (NYS: TGT) , and 10% at Wal-Mart. The three all offer pet products and may attempt to gain market share, but it's unlikely that any will match the product diversity or devote space to truly compete in the $4 billion pet-service segment. PetSmart's grooming, boarding, and training offerings alone hold 17% of the market and drive higher store traffic. What's more, customers who use these services spend three times as much as the average customer.

Foolish bottom line
Although all of the companies I've mentioned here will give you some exposure to the growing pet industry, if you're looking for that true niche player, I strongly believe PetSmart is the way to go -- not only because of the great growth opportunities it has ahead, but also because it's the top dog in the sector. I recently gave it a thumb-up CAPScall.

If PetSmart's not for you, but still want exposure to the retail industry, check out this free report about one retailer that reminds our analyst of a young Costco. The company has been named The Motley Fool's Top Stock for 2012, so don't miss out on your opportunity to uncover it today.

At the time this article was published Fool contributor Matt Thalman owns none of the companies mentioned above, but his German shepherd is a regular shopper at the local PetSmart. The Motley Fool owns shares of Costco Wholesale.Motley Fool newsletter serviceshave recommended buying shares of Procter & Gamble, Costco Wholesale, and PetSmart. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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