3 Reasons To Avoid Retail Store Stocks

It is just a far more efficient way to get merchandise to customers. And it is a second major reason why e-commerce has continued to gain ground on physical retail over the last decade-and-a-half.

Physical Retail Has No Moat

The most common long-term, structural competitive advantages ("moats") we encounter are: high switching costs, network effects, consumer bran advantage and economies of scale.

Do physical retailers have any of these?

HIGH SWITCHING COSTS

Years ago, you might argue that this was the case. For many towns and cities, residents relied on one large, general store for a lot of needs. That store had a major location advantage, as the next similar store could be a several hour drive away. But this is no longer the case. Denser urban development has led to more physical competition, and buying online is just a laptop away. It is very easy for consumers to cross-shop. Switching costs are nil.

NETWORK EFFECTS 

There are no network effects in retail. Let's move on.

CONSUMER BRAND ADVANTAGE

Several consumer goods brands have made the move to physical retail stores over the past 20 years (Apple, Nike, etc.), but we look at these companies as just that - consumer goods brands with a small retail presence. When talking about pure retailers, the number that have built meaningful brands are very small. Most folks simply don't care where they buy their Levi's or printer ink.

ECONOMIES OF SCALE:

Again, except in very rare cases (like Walmart), building large enough economies of scale in retail to have a price advantage is extraordinarily difficult, simply because there are so many outlets to sell products now.

For all intents and purposes, very few retailers can ever achieve any kind of long-term competitive moat. It is just not a business model that lends itself well to them.

The Exceptions

Throughout the previous sections, we've made some generalizations - but ones that apply to the vast majority of "brick-and-mortar" retail stocks you will encounter in the market.

However, there are a few exceptions - retailers that have done well over the long term, while still being based in physical stores.

One important category here are "need-it-now" items. It is unlikely you will choose the Internet to get those headache pills you need NOW, or the buns for the hamburgers you are making tonight, or that mulch you need to fix up the flower beds today. This is the reason that e-commerce has had limited impact on retailers like drug stores, grocery stores, and home improvement chains - despite a lot of dollars and effort to break into the space.

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Disclosure: Steve owns no stocks referenced here.

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