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Industry Analysis: Retail Store
Retailers differ from industrial companies in that they do not produce tangible products. They purchase merchandise from manufacturers in large quantities for resale to consumers at a profit. The domestic Retail Store industry is mature and highly competitive. Many retailers have been in business for the better part of a century and, thus, have had time to fully cover targeted markets. These companies must provide desirable products, while managing inventory and controlling costs, to succeed. From an investment perspective, the sector generally tracks the broader stock market, on average. Some retail stocks can be volatile, though, making them best suited for short-term accounts. However, there are a few well-established companies suitable for the conservative investors.
Consumer spending typically accounts for some two-thirds of Gross Domestic Product. Therefore, GDP trends usually indicate the health of the retail sector. In addition, measures of Consumer Confidence help gauge consumer spending and savings rates, which also relate to the performance of retailers. In tough times, consumers, having less disposable income, limit their outlays to necessary day-to-day items. Conversely, during strong economic periods, consumers are more willing to make big-ticket purchases. Observers should also keep watch on the Consumer Price Index. Most retailers resist absorbing higher wholesale prices, and attempt to pass on any increases to their customers. At a certain point, however, consumers will push back against price hikes, and retailers' sales and margins will then come under pressure.
There are many types of retailers. Consumers can afford to be choosy about where they shop, and retailers often distinguish their offerings through promotional activity. What sets one retailer apart from another is the quality, quantity, price, and selection of products available. Full-line department stores offer moderately priced products across several merchandise categories-for example, home appliances, electronics, cookware, linens, and apparel. Specialty department stores depend more on apparel, accessories, and cosmetics. Upscale specialty department stores, marketing top American and European fashion designer merchandise, charge a premium for their wares.
Aside from department stores, industry observers will find discounters. Discounters sell a broad selection of everyday items, such as stationary, sporting goods, toys, hardware, and over-the-counter pharmaceuticals. As growth opportunities diminished, a number of discounters began offering groceries to gain business. Another type of company is the wholesale club. Wholesale clubs have a lineup similar to that of discounters, but what sets them apart is they sell products from warehouse-like centers in bulk packages, under no-frills, self service terms, and charge a membership fee. Membership fees make up a large portion of operating profit.
One of the most straightforward ways retailers can expand sales is by opening new stores. It should be kept in mind, though, that new locations initially entail increased operating costs, some of which are fixed. Management must be careful not to open new stores in close proximity to existing ones. Doing so often results in sales cannibalization. Historical and planned store counts lend a view to a company's expansion strategy. For instance, during a recession, well-heeled retailers may try to gain share by developing stores within competitors' territories. Cash-strapped companies, on the other hand, may retrench, closing low-profit locations. The ability to build or lease new stores depends on a company's cash balance, debt, and available credit. Leasing property requires less capital and permits quicker expansion than does construction, but long-term agreements can make it difficult to close underperforming stores when cash needs to be conserved.
New stores allow retailers to boost year-to-year sales matchups. A better measure of sales growth is comparable store sales, or comps, which only include locations in existence for at least one year. If comps rise, profits post greater gains, since they do so with little additional fixed costs. Should comps fall, the retailer may have to streamline its operations to maintain profit margins. One way a retailer can improve comparable store sales is to accurately anticipate what merchandise its target demographic will find the most desirable. This can prove especially difficult for companies that sell apparel, since consumers tend to be rather fickle with regard to their individual fashion tastes. An effective advertising campaign, appealing store layout, and attractive signage are also ways that companies can increase traffic and sales. Furthermore, retailers have had to develop attractive websites to compete against a growing number of online competitors.
The difference between the prices retailers pay manufacturers for their goods and the prices they charge is called the markup. Cost of sales is what is paid to the manufacturers plus outlays for freight, store occupancy, employees, insurance, and utilities. Gross margin is a good measure of how well a company builds sales, sets the markup, and controls costs and expenses. Proper inventory management is vital. Too much inventory increases carrying costs and forces markdowns to improve turnover. (Turnover is the cost of sales divided by the average value of inventory over a given period.) Conversely, an overly lean inventory may translate into lost sales opportunities. Generally, the higher the turnover, the greater the flexibility in setting the markup; this improves the chances of maximizing profit.