Looking For Retail Diamonds In The Rough

Frequently, stock ranking screens are as good at picking out trends as they are at uncovering interesting investment opportunities. For example, consider our two value-based ranked screens (known as "Spells"): the Magic Recipe Spell and particularly the Deep Value Spell.

Perusing the two lists of around 80 unique stocks, one stark trend jumps out: the sheer number of traditional, "brick-and-mortar" retailers whose stocks now trade at far below-market levels against their trailing 12 month earnings and free cash flows.

A full 20 stocks - about 25% of all the positions - are brick-and-mortar retailers.

This raises 2 questions. One, what is causing this "retail recession" and is it a trend likely to continue, abate, or even accelerate? And two, are any of these stocks "diamonds in the rough" - e.g., are any of these companies likely to survive or even thrive in the conditions leading to these depressed valuations?

What's the Trend, Friend?

As to what is causing the "retail recession", the answer is pretty simple to discern. Retail sales overall are not declining. In fact, overall sales of hard goods in the U.S. grew almost 4% in 2016. So this is not a case of consumers pulling back spending in response to hard times. The market is growing, not declining.

But the market is also changing. And that change is away from physical store shopping and into online shopping.

Consider these facts. In 2007, e-commerce accounted for just over 3% of retail sales in the U.S. Last year, that rose to nearly 10%. E-commerce sales have been increasing at a rate exceeding 15% a year over that decade - with no signs of slowing (2016 came in at 16%).

OK, great. So the trend is towards online sales and away from stores. We can also discern that this is a trend that is likely to continue or even accelerate given the statistical history. That answers our first question. Now, what about the second?

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Disclosure: Steve owns no stocks referenced here.

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