Tuesday, December 22nd, 2009
How to Analyze Retail Stocks
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Retail companies may be easy to associate with for investors, but analyzing them can be a rather difficult endeavor. The good news is that by understanding a few common metrics, as well as company-specific and macroeconomic factors, investors can an excellent grasp on a retailer’s investment merits and potential growth going forward.
Determining Real Growth with Same-Store Sales
Same-store sales are extremely important monthly metrics used by retailers that reveals how stores have performed on a period-to-period basis. Of course, investors would like to see both sequential and year-over-year growth, but often times retailers are seasonal in nature. For example, sales during the fourth quarter Christmas holiday season are usually the highest.
Perhaps more importantly, same-store sales show investors what portion of new sales have come from organic sales growth versus what growth has come from opening new stores. After all, building new stores is an unsustainable growth model as a saturation point is eventually reached. As a result, organic or same-store growth is a great way to determine true growth.
Measuring Efficiency with Square Footage Data
Sales per square foot, a statistic that is often revealed in conference calls or quarterly financial reports, is a reliable indicator showing how good management is at using store space and allocating resources. Generally speaking, a higher sales per square foot figure is better for investors, and should always be compared to its peer group.
The sales per square foot metric can be a key indicator of management efficiency and product mix. For example, Wal-Mart introduced groceries inside many of its stores not long ago, and the moved helped to increase its sales per square foot. As a result, investors were able to clearly see that the strategy was an effective one, which could also pay off in other retailers like Target.
Examining Worth with Book Value and Ratios
The value of a retailer’s assets can be easily measured by calculating its tangible book value per share. Calculating this number is as easy as taking the total shareholder’s equity from the balance sheet and subtracting intangible assets like goodwill, licenses, brand recognition and other assets. This number is then divided by the number of shares outstanding and compared to stock’s price.
Similarly, the value of a retailer’s growth can be ascertained by comparing its price-earnings multiple to its peer multiples and long-term growth rate. The so-called PEG ratio (price-earnings-to-growth) can be calculated by dividing the price earnings multiple by the long-term growth rate. Most investors see a PEG of 1.0 as a fair value, and any stock below as undervalued.
Diversification and Other Considerations
Investors should also be mindful of the geographic diversification of retail stores. Obviously, stores that are more spread out geographically reduce risks associated with economic declines in certain states or countries relative to others. Investors can also look at promotional activities as a way to determine how exactly retailers are driving more traffic to their stores.
Meanwhile, investors can look at many other metrics to gauge a retailer’s successes as well. These trends can include inventory or accounts receivable trends versus competitors or historic periods, as well as trends in gross margins over time and relative to competitors.
The Takeaway…
- Investors have a number of retail-specific measures that they can use to evaluate retailers, ranging from promotional activities to book value and financial ratios.
- Same-store sales is the most-watched figure put out by retailers in their quarterly and annual financial statements, as they take out store growth and non-tangible income.
Written by Simon Monger
