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James Li
James Li
Articles (776)  | Author's Website |

6 Retail Stocks to Consider as Sears Nears Final Demise

Retail industry offers good, high-quality alternatives to icon destined to fail since 2016

In light of Sears Holdings Corp.’s (SHLDQ) potential liquidation, investors might wonder if there are alternative retail companies that offer stronger value potential. According to the Greenblatt magic formula screen, the top five retail companies with at least a four-star business predictability rank include Sally Beauty Holdings Inc. (NYSE:SBH), Winmark Corp. (NASDAQ:WINA), TJX Companies Inc. (NYSE:TJX), Ross Stores Inc. (NASDAQ:ROST) and O’Reilly Automotive Inc. (NASDAQ:ORLY). Additionally, one honorable mention goes to Ulta Beauty Inc. (NASDAQ:ULTA).

Bankruptcy court gives faltering retailer one final chance

CNBC columnists Lauren Hirsch and Lauren Thomas said on Tuesday that although Sears said “no deal” to Chairman Edward Lampert (Trades, Portfolio)’s $4.4 billion bid to buy the retailer, the bankruptcy courts gave Lampert a second chance to save the Hoffman Estates, Illinois-based retailer and over 50,000 jobs. Hirsch and Thomas said ESL Investments must pay a $120 million deposit by 3 p.m. Wednesday, whereupon Sears will then allow Lampert to “participate in a previously scheduled auction” on Monday.

Despite Lampert’s efforts to keep the struggling retailer alive, GuruFocus has warned readers over the past two to three years about the inevitable demise of Sears, a company that still has several red flags, including increasing long-term debt, declining profit margins and a weak Piotroski F-score of 2. Such warning signs increase the probability of financial distress, which is essentially now 100% for Sears.

Gurus that have stood with Sears to the bitter end include Lee Ainslie (Trades, Portfolio), Francis Chou (Trades, Portfolio) and former director Bruce Berkowitz (Trades, Portfolio), who has been selling his shares quarter over quarter since second-quarter 2017.

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Remember, buy only good companies

Berkshire Hathaway Inc. (NYSE:BRK.A)(NYSE:BRK.B) CEO Warren Buffett (Trades, Portfolio) underscored four key investing criteria for good companies: predictable earnings, strong profit margin growth, no meaningful debt and attractive share price based on the price-earnings-to-growth (PEG) ratio. One example is Ulta, a retail company specializing in cosmetics and fragrance products. The company’s five positive investing signs include zero long-term debt, consistent revenue growth, expanding operating margins, a strong Piotroski F-score of 7 and a price-earnings ratio near a five-year low. Such signs effectively match Buffett’s description of a good company; additionally, Ulta’s financial strength and profitability both rank 9 out of 10.

GuruFocus developed two value screens based on Buffett’s key principles: the undervalued predictable screen and the Buffett-Munger screen.

Gotham Capital asset manager Joel Greenblatt (Trades, Portfolio) developed a magic formula screen that considers two key financial criteria: earnings yield and return on capital. Greenblatt’s formula assigns stocks with higher yields and returns a higher rank than those with lower yields and returns.

Sally Beauty Holdings

With an earnings yield of 11.28% and return on capital of 49.35%, Denton, Texas-based Sally Beauty Holdings is the top-ranked stock on the list.

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Sally Beauty provides a wide variety of beauty products through its two business segments: Sally Beauty Supply and Beauty Systems Group. GuruFocus ranks the company’s profitability 8 out of 10: even though operating margins have contracted approximately 3.5% per year over the past five years, Sally Beauty’s profit margins and returns still outperform over 85% of global competitors.

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Gurus that own shares of Sally Beauty include Mario Gabelli (Trades, Portfolio) and Chuck Royce (Trades, Portfolio), two of our speakers at our upcoming value conference. The latter is also our keynote speaker for the conference.

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The GuruFocus Undervalued-Predictable model portfolio added 714 shares for $17.05 on Jan. 1, the most-recent rebalance date. The model portfolio has returned an annualized 12.20% over the past 10 years, approximately 1.11% higher than the annualized return of the Standard & Poor’s 500 index over the same period.

Winmark

Minneapolis-based Winmark ranks second on Greenblatt’s list, with an earnings yield of 6.52% and a return on capital that outperforms 99.99% of global competitors.

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Winmark creates, supports and finances businesses with brands like Once Upon a Child, Play-it-again Sports and Music Go Round. GuruFocus ranks the company’s profitability 8 out of 10 on several positive signs, which include expanding profit margins, consistent revenue growth and a dividend yield near a 10-year high. Winmark’s three-year revenue growth rate of 11.10% is outperforming 78% of global specialty retail companies.

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The GuruFocus Buffett-Munger model portfolio added 71 shares for $159 on Jan. 1.

TJX Companies

Framingham, Massachusetts-based TJX Companies ranks third on Greenblatt’s list, with an earnings yield of 7.24% and return on capital of 78.99%.

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TJX Companies offers and retails off-priced apparel and various home furnishings like accent furniture, lamps and rugs. GuruFocus ranks the company’s profitability 9 out of 10 on several positive indicators, which include consistent revenue growth and a strong Piotroski F-score of 8. Even though the company’s operating margin has contracted approximately 1.6% over the past five years, TJX’s profit margins are still outperforming over 82% of global competitors.

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The GuruFocus undervalued predictable model portfolio add 272 shares of TJX for $44.74 on Jan. 1. Other gurus with large holdings in TJX include PRIMECAP Management (Trades, Portfolio) and Diamond Hill Capital (Trades, Portfolio).

Ross Stores

Dublin, California-based Ross Stores ranks fourth on Greenblatt’s list, with an earnings yield of 6.42% and a return on capital of 85.94%.

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Ross primarily markets name-brand and designer apparel, accessories, footwear and home fashions to middle-income consumers. GuruFocus ranks the company’s financial strength 8 out of 10 and profitability 9 out of 10 on several good signs, including a solid Piotroski F-score of 8, a robust Altman Z-score of 10.5 and a dividend yield near a three-year high. Additionally, the company’s net profit margin is near a 10-year high of 10.68% and outperforms 88% of global apparel stores.

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O’Reilly

Springfield, Missouri-based O’Reilly ranks fifth on Greenblatt’s list, with an earnings yield of 6.02% and a return on capital of 52.91%.

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O’Reilly sells aftermarket automotive parts, tools and accessories, serving professional and do-it-yourself customers in the U.S. GuruFocus ranks the company’s profitability 9 out of 10 on several good signs, which include consistent revenue growth and a strong Piotroski F-score of 7.

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See also

Premium members have access to all our value screens, including the Ben Graham net-net screen and the historical low price-sales screen.

Disclosure: As of this writing, the author is long ROST, ORLY and ULTA.

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About the author:

James Li
I am an editorial assistant and researcher at GuruFocus. I have a Master's in Finance from SMU, and I enjoy writing reports on financial trends and investor portfolios. Follow me on Twitter at @JamesLiGuru!

Visit James Li's Website


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