The Zacks Retail – Discount Stores industry comprises companies that offer apparel, accessories, footwear, beauty products, personal and baby care products, cleaning products, pet supplies, and food and beverage products.

The companies also provide home textiles, home furnishings, housewares, toys and seasonal décor products. They sell their products through stores as well as digital channels. Some of the companies operate membership shopping warehouse clubs offering branded and private-label products in a range of merchandise categories.

Let’s take a look at the industry’s three major themes:

• The industry’s prospects are closely tied to the purchasing power of consumers. A robust job market and higher disposable income are working in favor of industry participants. Also, the strategy to sell products at discounted prices has helped industry players expand their customer base, which comprises lower to middle income group. Moreover, a differentiated product range in sync with customers’ spending habits enables the companies to enrich the shopping experience, resulting in market share gains and higher sales per square foot.
   
• Players in the industry are steadily developing omni-channel capabilities, which include technological updates and store remodels. They are undertaking brand enhancement efforts with off-price models and innovative customer-friendly approach such as same-day delivery options. These along with a compelling store growth story at convenient locations and focus on demand-driven products lend support. Better pricing, effective inventory management, and merchandise and operational initiatives should boost revenues of the industry constituents.
   
• The companies in the industry are vying for a bigger share on attributes such as price, products and speed to market. Of late, the retail-discount space has turned highly competitive with the growing dominance of Amazon (AMZN). This has compelled a number of players to strengthen their digital ecosystem and boost shipping and delivery capabilities. While these endeavors drive sales, they entail high costs. Apart from these, any deleverage in SG&A rate, higher labor and occupancy costs, and increased marketing and other store-related expenses might also compress margins. Nonetheless, companies are resorting to cost containment.

Zacks Industry Rank Indicates Bright Prospects

The Zacks Retail – Discount Stores industry is housed within the broader Zacks Retail – Wholesale  sector. The industry currently carries a Zacks Industry Rank #107, which places it in the top 42% of more than 250 Zacks industries.

The group’s  Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bright near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the top 50% of the Zacks-ranked industries is a result of positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually becoming hopeful of this group’s earnings growth. In the past year, the industry’s earnings estimate for the current year has increased approximately 7.3%.

We will present a few stocks that have the potential to outperform the market based on a strong earnings outlook. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.

Industry vs. Broader Market

The Zacks Retail – Discount Stores industry has outperformed both the broader Retail – Wholesale Sector and the Zacks S&P 500 composite over the past year.

The stocks in this industry have collectively gained 6.4% against the Zacks S&P 500 Composite and Zacks Retail – Wholesale sector’s decline of 7.2% and 7%, respectively.

One-Year Price Performance

Industry’s Current Valuation

On the basis of forward 12-month Price-to-earnings (P/E) ratio, which is commonly used for valuing retail stocks, the industry is currently trading at 18.89 compared with the S&P 500’s 16.04 and the sector’s 22.48.

Over the last five years, the industry has traded as high as 25.19X, as low as 18.39X and at the median of 21.86X, as the chart below shows.

Price-to-Earnings Ratio (Past 5 Years)

Bottom Line

Certainly, discount retailers have succeeded in creating a niche despite the rising popularity of online retailers that has compelled many traditional operators to exit. This has been largely supported by investments, focus on cost savings and introduction of loyalty and marketing programs. However, costs associated with promotional activities and an aggressive pricing strategy on account of stiff competition remain deterrents.

That said, we are presenting two stocks from the Retail – Discount Stores industry, which carry a Zacks Rank #2 (Buy) and are well positioned to capitalize on the opportunities. You can see the complete list of today’s Zacks #1 Rank stocks here.

Ross Stores, Inc. (ROST): For this operator of off-price retail apparel and home fashion stores, the consensus EPS estimate for the current fiscal year has increased by a penny over the past 30 days. Moreover, the company’s bottom line has outperformed the Zacks Consensus Estimate by an average of 3.6% in the trailing four quarters. The stock, which has increased 8.4% over the past year, has an estimated long-term earnings growth rate of 10%.

Price and Consensus: ROST

Tuesday Morning Corp. (TUES): For this off-price retailer of home textiles, home furnishings, housewares, toys and seasonal décor products, the consensus estimate for the current fiscal year has been stable over the past 30 days. Moreover, the company’s bottom line has outperformed the Zacks Consensus Estimate by an average of 16.5% in the trailing four quarters.

Price and Consensus: TUES

Given the promising prospects of the Retail – Discount Stores industry, investors may hold on to some stocks that can fetch great returns in the near future. Here are two such stocks with a Zacks Rank #3 (Hold):

Burlington Stores, Inc. (BURL): Shares of this retailer of branded apparel products have gained 34% in a year. The Zacks Consensus Estimate for the company’s current fiscal EPS has risen 2.6% in the past 60 days. The company has an estimated long-term earnings growth rate of 20.8%. The company delivered average positive earnings surprise of 13% in the trailing four quarters.

Price and Consensus: BURL

The TJX Companies, Inc. (TJX): Shares of this off-price apparel and home fashions retailer have increased about 23% in a year. The Zacks Consensus Estimate for the company’s current fiscal EPS has remained unchanged in the past 30 days. The company has an estimated long-term earnings growth rate of 11.1%. The company delivered average positive earnings surprise of 8.1% in the trailing four quarters.

Price and Consensus: TJX