Retail Stocks That Can Thrive in a Down Economy

The recession is officially over, but slow economic growth may be here to stay. If so, it might be prudent for investors to target stocks that are likely to thrive in slow-growth economic conditions but that also stand to benefit when economic growth picks up again (someday soon, hopefully).

That's one of the investing concepts advanced by Neil Hennessy, chairman and chief investment officer of the Hennessy Funds. Hennessy says even in difficult times, smart stock-pickers can make money for their clients, and he believes paying attention to economic trends is a good way to home in on companies with superior growth prospects.

"Money managers can beat the market," says Hennessy. "You just have to know where you want to be."

By that Hennessy means, money managers should know which industries they want to invest in for the long term. Using his signature Focus 30 Fund (HFTFX) as a measure, Hennessey says consumer-focused investments that emphasize retail will take off when economic growth resumes, so he has started to adjust his portfolio accordingly.

Hot on Low-End Retailers

The Focus 30 Fund identifies the 30 stocks with a market cap between $1 billion and $10 billion that have the highest one-year price appreciation. Hennessy buys them in equal amounts and holds them for one year, then rebalances the portfolio. The fund has an 18% return so far in 2010, and as 2011 approaches, Hennessy has made several adjustments to the Focus 30 portfolio that he believes will increase its growth potential.

Even though there has been plenty of negative news about consumer spending trends, Hennessy is hot on low-end retail, primarily because it has flourished during the recent recessionary environment. Chances are, value-conscious consumers will keep these companies profitable when the economy picks up. Hennessy recommends Family Dollar Stores (FDO) and Dollar Tree (DLTR) because everything they sell is generally $10 or less. As of Oct. 22, shares of Family Dollar are up 63% in 2010, trading at $45.41, while Dollar Tree is up 7% for the year, trading at $51.83.

Hennessy also reasons that as more people find regular employment and the economy heats up, consumers will take the next step and begin spending money at specialty retailers such as Williams Sonoma (WSM), Crocs (CROX) and ULTA Salon Cosmetics & Fragrance (ULTA). The high-end, well known brands Williams Sonoma carries should always sell, and the Crocs brand has proven to have a strong following. As for Ulta Salon, Hennessy says, "When women are going to get their hair done, they may pick up some of the products that are sold there."

As of Oct. 22, shares of Williams Sonoma traded at $31.99, up 54% for the year. Shares of Crocs were trading at $13.56 up 136% year-to-date and Ulta Salon was trading up 70% for the year at $31.

"Feeling of Achievement"

Another area of consumer demand in retail is in the "Do-It-Yourself" category. Retailers that cater to the DIY crowd have done well, Hennessy says, because saving money by making or fixing things yourself is an exercise that can lead to long-term changes in spending habits.

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"If you're cutting back a little bit, and instead of buying that baby blanket, you make it, it gives that person a feeling of achievement," says Hennessy. "Once you get that feeling of achievement, you're just not going to go back to your regular ways again. It will take a while."

Hennessy believes Jo Ann Stores (JAS) and Advanced Auto Parts (AAP) are set to benefit from this consumer trend. As of Oct.r 22, shares of Jo-Ann Stores were trading at $40.72, up 12% for the year. Advanced Auto Parts was trading at $61.32 a share, up 51% for the year.

By keeping a diversified focus on retailers, Hennessy says, "This portfolio is positioned to take advantage of a slow-growth economy or an economy that is coming out of a recession."

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