Investing in Retail Stocks: Everything investors need to know

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Since the pandemic began, retail stocks and shares have been under the investing radar of many individuals. The weak position of this stock market sector during lockdowns didn’t exactly exhibit an alluring investment opportunity, especially for non-essential stores.

Yet today, the situation is quite different. And some investors are starting to see this as an opportunity in disguise. I believe the pandemic has led the retail industry towards a long-overdue reset. And the shops that survived the culling are shifting towards a more profitable and stable position than ever before.

With that in mind, let’s discuss how the industry is reshaping and what it means for investors thinking about investing in retail stocks.

What are Retail Stocks?

Retail companies sell discretionary or staple goods to consumers directly. The products can be sold via brick-and-mortar stores or through an online website. The pandemic has undoubtedly accelerated the transition to online spending, with the convenience of next-day delivery enticing consumers to switch. And so, e-commerce is slowly becoming a more prominent sales channel.

In-store sales are still around for roughly 70% of all consumer spending today. But retail stocks aren’t blind to shifts in consumer behaviour. That’s why almost all of the leaders in the space, like Tesco and J Sainsbury, have been heavily investing in revamping their online user experience.

As Deloitte’s sector report states, “The trick is to create a seamless and simple user experience and to get the fulfilment done as quickly as possible“.

The Risks and Challenges Faced by Retail Shares

With the sector transforming itself, 2022, for many, is a year of opportunity to invest in this industry. After all, these companies don’t exactly trade at high multiples. But while retail shares may look “cheap”, there are some risks to consider before investing in this space.

  • Evolving Customer Demands and Expectations – For stores to thrive, adapting to the changing consumer shopping habits is very important. Covid-19 has changed the shopping habits of every shopper. Moreover, retailers need to stay updated with the seasonal trends, and sudden changes in customer shopping behaviours – something that’s easier said than done.
  • Technological Innovation – The explosive growth of e-commerce has led to a surge of technological disruption. Consumers now prefer to have choices at their fingertips before making a purchase. Therefore, retail stocks need to understand the importance of innovation in technology. Similarly, the companies should be able to identify the best way to meet consumer demands and what their business needs.
  • Customer Retention – Retaining your customers is becoming increasingly important because of all the choices customers have.
  • Marketing in the Digital Era – Today, retail companies have to reach out to potential customers via multiple channels. Moreover, customers have grown used to one-on-one engagement on different platforms. As a result, it has raised the bar for retail companies about how effectively they need to reach their existing and potential customers via marketing.
  • Internal Communication – As retail companies spread across borders and the market gets complex with every passing day, internal communication has become quite a challenge. Internal communication is vital to improving and integrating company departments and business processes. Incorporating the latest software and discarding outdated methods is the key to becoming internally strong.

Key Financial Metrics to Consider Before Investing in Retail Stocks

Every sector is different. And when it comes to retail, emphasis needs to be placed on different factors that may not apply to other industries. So, let’s look at the financial metrics that I believe are the most important to watch.

  • Sales-Per-Square-Foot – This is a crucial financial metric for retail stocks. It indicates how efficiently the management is using its stores and allocating resources.
  • Gross Margin Trend – Gross Margin is an excellent indicator to identify how profitability is evolving. In addition to it, it also indicates the market’s expectations for the future.
  • Inventory Growth Trend – This trend should match the revenue trend. But if the inventory is rising faster than revenue, then it’s a red flag in my experience.
  • Accounts Receivable – This financial metric should be growing with revenue for retail stocks. Therefore, if the growth rate is faster than revenue, it means a payment issue for the retail company. Ultimately it can lead to stagnant sales in the future.
  • P/E Ratio – P/E ratio indicates the value per share for investors. This ratio, when compared with the expected earnings growth rate, is an excellent indicator of the retail stock’s stable operations.

Key Terms to Know before Investing in Retail stocks

Despite the simplistic nature of selling products to consumers, a few bits of jargon are scattered around. And when it comes to keeping up with the latest trends, it’s important to know the terminology that retail stocks and shares use.

  • Anchor Store – An anchor store is a big department store in a mall.
  • ATS -ATS stands for average transaction size, which is the average amount spent on a single transaction or purchase.
  • Brick and Click – A brick-and-click business is a retail store with a brick-and-mortar establishment, as well as an e-commerce website.
  • Cross Merchandising – When retailers display unrelated products from different categories together, this is known as cross-merchandising.
  • Consignment Merchandise – This is merchandise that isn’t owned or paid for by the retailer until it’s sold.
  • Conversion Rates – Conversion rates measure the percentage of visitors that make a purchase.
  • Depth of Assortment – This is the amount of each item or different styles of a product that a retailer stocks.
  • Dropshipping – A retailer partners with a dropship supplier who takes care of virtually the entire process for them. Once the product is ordered, the dropship supplier will ship them directly to the retailer’s customer.
  • Electronic Article Surveillance (EAS) – Electronic article surveillance is a technological method for preventing shoplifting.
  • Franchise – A franchisor issues a license to the franchisee to operate under the business’ name.
  • Green Retailing – Green retailing is an increasingly popular approach to managing a retail business by implementing environmentally friendly and sustainable practices and processes.
  • Niche Retailing -A niche retailer only sells a single type of product within a specific category.
  • Units per Transaction (UPT) – Units per transaction is the metric that measures how many items a customer purchases in any given transaction.

Market Size and Growth Forecast of the Retail Industry

Without a doubt, this industry has witnessed several changes in the past few years due to unstable economic conditions globally. In fact, the economy slowed in 2019 and crashed in 2020 due to the Covid-19 outbreak. And now, with a consumer spending crunch underway as energy bills skyrocket, the future looks quite uncertain for retail shares.

Yet that doesn’t mean there isn’t growth potential. In 2022 global retail spending hit $27.34trn, and this is expected to continue trending upward, reaching $31.27trn by 2025, presenting a roughly 5% annual compounded growth rate.

That’s hardly the most exciting growth opportunity. But with demand unlikely to drop anytime soon, the multi-trillion dollar industry does present lucrative opportunities for those thinking about investing in retail stocks and shares.

Top Retail Stocks in the UK by Market Capitalisation

Company Market Cap. Category Description
Tesco (LSE:TSCO) £19.6bn Staples Tesco PLC, together with its subsidiaries, engages in retailing and retail banking activities.
Next (LSE:NXT) £8.5bn Discretionary NEXT plc engages in the retail of clothing, footwear, and home products in the United Kingdom and internationally.
Ocado (LSE:OCDO) £6.96bn Staples Ocado Group plc operates as an online grocery retailer in the United Kingdom and internationally.
JD Sports Fashion (LSE: JD) £6.35bn Discretionary JD Sports Fashion plc engages in the retail of branded sports fashion and outdoor clothing, footwear, accessories, and equipment for kids, women, and men.
J Sainsbury (LSE:SBRY) £5.4bn Staples J Sainsbury plc engages in the food, general merchandise and clothing retailing, and financial services activities.

Top Retail Stocks in the US by Market Capitalisation

Company Market Cap. Category Description
Amazon (NASDAQ:AMZN)  $1.17trn Discretionary, Inc. engages in the retail sale of consumer products and subscriptions. The company operates through three segments: North America, International, and Amazon Web Services (AWS).
Walmart (NYSE:WMT) $353.7bn Discretionary, Staple Walmart Inc. engages in the operation of retail, wholesale, and other units worldwide. The company operates through three segments: Walmart US, Walmart International, and Sam’s Club.
Home Depot (NYSE: HD) $317bn Discretionary Home Depot, Inc. operates as a home improvement retailer.
Costco (NASDAQ:COST) $208.6bn Discretionary, Staple Costco Wholesale Corporation engages in the operation of membership warehouses.
Target Corporation (NYSE:TGT) $77bn Discretionary Target Corporation operates as a general merchandise retailer in the United States.

Should I Invest in Retail Shares?

No doubt, this industry is evolving. In fact, retail stocks have many sophisticated opportunities today to meet the growing needs of the industry. In my opinion, adapting to the rapidly changing business and keeping customers engaged through a multi-channel marketing approach is the key to surviving the digital boom within the retail sector.

Whether or not the current industry leaders can stay on top has yet to be seen. As ever with shifting landscapes, disruptive young businesses could eventually dethrone existing titans. That, to me, sounds like an interesting avenue to explore. Therefore, personally, I think investing in retail stocks and shares could be a lucrative move for my portfolio.

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Saima Naveed does not own shares in any of the companies mentioned. The Money Cog has published Premium reports on NEXT Plc, Tesco, and Ocado. Views expressed on the companies and assets mentioned in this article are those of the writer and therefore may differ from the opinions of analysts in The Money Cog Premium services.

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