Discount Retailer Stocks: Why They’re Tops

George's best stock advice to you on investing in retail stocksEveryone knows that consumer spending drives the economy and gross domestic product (GDP) growth. The headline Retail Sales reading for April jumped 0.5%, which was slightly below the estimate of 0.6% and down from an upwardly revised 0.9% in March. Excluding the auto portion, Retail Sales increased a slightly better than expected 0.6%, although this is lower than the upwardly revised 1.2% in March.

On the plus side, consumers are spending, but the lack of consistency is troublesome. And, given that gasoline prices are high, it reduces the disposable income that consumers have to spend on goods and services. You may not buy that DVD player you had been eyeing. This may not sound like a big deal, but think about it this way: not buying that DVD player has a trickle-down effect as far as spending goes and negatively impacts total spending.

But this is not to say that you should avoid retail stocks. A key part of investment advice that leads to success is selective picking.

My best stock advice to you would be to stick with the leading discount bellwether retail stocks. In the large-cap area, these include Wal-Mart Stores, Inc. (NYSE/WMT), Target Corporation (NYSE/TGT), and Costco Wholesale Corporation (NASDAQ/COST).

Costco reported a 12% jump in its key same-store sales reading, well above the 8.9% estimate polled by Thomson Reuters. Net sales for April surged 17% year-over-year. The results are consistent and continue to show steady growth; but, for that extra bit of growth, you should look at the smaller discount retail companies.

Costco, for instance, has a market cap of $35.73 billion and is estimated to report sales growth of 11.4% and 7.9% for the FY11 and FY12, respectively.

For comparison, take a look at small-cap PriceSmart, Inc. (NASDAQ/PSMT), an operator of 28 warehouse clubs in 11 countries in Central America and the Caribbean. PriceSmart reported a booming 21.5% increase in its same-store sales for the five weeks to May 1, along with a 37% year-over-year rise in April net sales. These are well above the growth metrics for Costco. Consider the comparative sales growth for PriceSmart, which is 15.1% and 9.5%, for the FY11 and FY12, respectively. The growth estimates are probably conservative and could really take off if the expansion continues.

Another interesting discounter is large-cap Dollar General Corporation (NYSE/DG), which operated a staggering 9,300 stores across 35 states. Dollar General has reasonable valuation and above-average price appreciation potential for investors.

And when housing picks up, I expect spending to continue to increase, especially on non-essential goods and services reflected by Durable Goods.

It does appear that a reversal is occurring in retailing. The key is to look for same-store sales growth in retailers that sell non-essential goods. Increases here could mean that consumers are spending on goods and services that are non-essential. These include electronics, appliances, furniture, and autos, and other big-ticket items.

My favorites in the retail space continue to be the discounters and big-box stores. The big-box stores are now selling a broad range of electronics and are adding to their product lines. This will offer consumers a one-stop place for shopping and make more money for these companies.