My Best Stock Advice on the Retail Sector

The upward move of the retail sector is impressive given the constraints. George senses that retailers are just more efficient as far as production and inventory control and have not been caught with excess inventory as was the case in the past. This is not to say that the retail sector is the place to make money, but there are some winners and market leaders. Consumer spending drives the economy and gross domestic product (GDP) growth, accounting for about 70% of GDP in the U.S.

The retail sector has been rebounding in spite of the lack of jobs and the declining home prices. The S&P Retail Index (RLX) is trading near its 52-week high, up 37% from the 52-week low. The RLX recently traded at its highest level since the index was created in 2007.

The upward move of the retail sector is impressive given the constraints. I sense that retailers are just more efficient as far as production and inventory control and have not been caught with excess inventory as was the case in the past. This is not to say that the retail sector is the place to make money, but there are some winners and market leaders.

The headline Retail Sales reading for June increased 0.1%, slightly above the estimate calling for a decline of 0.2% and up from an upwardly revised negative 0.1% in April. Excluding the auto portion, Retail Sales were flat and in line with estimates.

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On the plus side, consumers are spending, but the lack of consistency is troublesome. And, given that gasoline prices are high, this 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 and negatively impacts total spending.

But this is not to say that you must avoid retail. The key for success is selective picking.

My investment advice and 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 14% jump in its key same-store sales reading in June, well above estimates. Net sales for June surged 18% year-over-year. The results are consistent and continue to show steady growth, but, for that extra margin of growth, you should look at the smaller discount retail companies.

Costco, for instance, has a market cap of $34.55 billion and is estimated to report sales growth of 12.8% and 8.1% for the FY11 and FY12, respectively.

For comparison, take a look at small-cap PriceSmart, Inc. (NASDAQ/PSMT; market cap; $1.73 billion), an operator of 28 warehouse clubs in 11 countries in Central America and theCaribbean. PriceSmart reported a booming 19.7% increase in its same-store sales in June, along with a 21.1% year-over-year rise in June net sales. These are well above the growth metrics for Costco. Consider the comparative sales growth for PriceSmart, which are 22.3% and 14.2%, 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 operates a staggering 9,300 stores across 35 states. Dollar 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 consumers are spending on goods and services that are non-essential. These include electronics, appliances, furniture, 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 line. This will offer consumers a one-stop place for shopping and make more money for these companies.