When it comes to major sectors in the Canadian stock market, most investors think of the top three: energy, materials, and financial. These are great industries to invest in, sure, but if you want to diversify your investment portfolio, you’ll probably want to branch out to other market sectors. Like, retail.
Retail stocks can be a great addition to any investment portfolio. Not only can they help you create a well-balanced portfolio, but they also give you the opportunity to invest in some of your favorite stores.
If you think retail stocks are right for you, let’s take a closer look and see what they entail, as well as how to pick the right one.
Related: List of companies in the TSX consumer discretionary sector
Retail stocks are companies that sell finished products and services directly to consumers. They fall under the “consumer discretionary sector,” which, unlike the “staples sector,” means they sell products and services that many of us want, but don’t absolutely need.
Retail stocks are a diverse bunch, ranging from electronics to food to books and toys and sporting goods. Businesses that fall under the retail stocks category include:
In Canada, retail stores have had a long and productive history, though with the recent pandemic, as well as a rise in e-commerce, the retail industry has seen some major changes. Of the hundreds of retails stocks out there, here are a few Canadian retail stocks that have risen to the top.
Identifying great retail stocks involves more than just picking out your favorite stores. Since the retail industry can be especially vulnerable to poor economic conditions (when money is tight, retail purchases are usually the first to go), you want to be sure you invest in retailers that can stand the test of time.
For that reason, you definitely want to dig into a retailer’s financial numbers and data to see where it’s heading. It’s not easy, sure, but trust us — it’s worth the time. To help you get started, here are seven key things to analyze as you’re looking at retail stocks.
Arguably the most important factor to consider is growth. If a retailer’s sales aren’t growing, if they’re not selling more and more products year-over-year, that’s a good sign the retailer store is heading for hard times.
One key metric to help you analyze sales growth is called same-store sales or comparable-store sales. Basically, same-store sales helps you see how much (or how little) a retailer’s existing stores have grown over a specific period of time (monthly, quarterly, annually). Same-store metrics apply to stores that have been open for a year or longer, and they’re expressed as a percentage.
For example, if a retailer reports that it’s same-store sales for 2020 increased by 15%, that means the company has increased sales by 15% since 2019.
Same-store metrics can help you gauge if a company is building its customer base, or if its products and services are no longer attracting people. If, for instance, you see same-store sales falling every quarter for the last year, that’s a clear sign the retail store isn’t selling as much product.
Every retailer spends money to make money. Retailers pay production costs, including buying materials to make products. They have the shipping costs, such as shipping the product from manufacturers to warehouses to retail stores. And finally they have labor costs, what they pay employees to sell their product.
If you add up all the costs of production and subtract them by the final price the product sells at, you’d arrive at the gross margin.
Simply put, gross margin measures the costs of goods against the final sale price of those goods. For example, if Company A earns $500,000 in sales revenue, but pays $150,000 in both manufacturing and labor costs, its gross margin would be $350,000.
Another way to look at gross margin is to see it as how much a company earns for every dollar it brings in (this is the way retailers often report their gross margins). For instance, if Store A has a 30% gross margin, that means it earns roughly $.30 for every dollar of revenue it brings in. If Store B, which sells goods comparable to Store A, has a 40% gross margin, then it retains $.40 of its sales, $.10 more than Store A.
Gross margins can vary greatly across different retail sectors, so it’s best to compare gross margins between similar stores. Even better is to look at the gross margin of a single store to see how its increasing or decreasing over time.
Every quarter, retail stores issue three important financial statements: balance sheets, profit & loss or P&L statements, and cash flow statements.
When looked at together, these three statements give you a big picture view of how a company is performing financially, how much it’s earning versus how much its spending, and what its long-term financial health looks like. When looked at separately, each one gives you a unique perspective on a company’s financial performance.
If you’re unfamiliar with financial statements, here’s a quick summary of each one.
A balance sheet lists all of a company’s assets, liabilities, and equities in an easy to read format. In order to “balance,” assets must equal liabilities plus equities. For retail stores, inventory is a part of the assets, and as long as the inventory is more valuable than the liabilities (debts), the store is in good shape.
Also known as the income statement, profit & loss or P&L statements track the revenue of a retailer, the costs the retailer pays in a specific period, and the net profit generated. P&L statements basically tell you how much a company brings in versus how much it spends over a specific period.
A cash-flow statement breaks down how much a company spends into smaller and smaller categories. It helps you see exactly where a retailer’s money comes from, as well as where it’s going (labor, mortgages, costs of goods, research).
Inventory turnover basically measures how many times a retail store sells and restocks its inventory over a specific period of time.
To calculate it, you simply take the total cost of goods sold and divide it by the average inventory for a period. For example, if Company A sells $1 million in products for a given year, and its average inventory was $250,000, then their turnover number is four ($1 million / $250,000 = 4). That means, Company A had to restock its inventory four times during the year.
Retail stores with a low inventory turnover may be struggling to sell their products. Having a massive backlog of unsold goods could lead to large promotions or sales, which could represent a loss to the company.
If there’s anything the pandemic has taught us, it’s this — in order to survive, retail stores must have a strong e-commerce platform. At this point, it’s almost impossible for a retail store to become a national leader, not to mention compete for its future survival, without an attractive and easy-to-navigate online store.
To analyze a company’s web presence, simply go to their website and try it out for yourself. If the interface is clunky, or the pages are slow, that might indicate the retailer hasn’t given enough attention to their digital presence.
In addition to an online store, you also want to analyse a company’s digital presence, too. If the retailer is in the grocery sector, for instance, they should have pick-up and delivery services on all the key delivery apps. Depending on the company, they should probably have an app of their own, especially one that allows customers to scan QR codes or get notified of deals.
A commonly overlooked retail metric is real estate. Retailers with brick-and-mortar stores often add extra value to their companies simply by owning property in thriving markets. Even if a company is performing poorly, the value of its real estate alone could help it stay afloat.
A wider network of stores could also protect retailers against highly localized market volatility. If a retailer has all of its stores in a storm-prone region, for instance, it’s putting a major risk on its profits. All it takes is one big storm to make stores inaccessible, or to lower the appeal of its products to consumers. With stores located in different regions, provinces, even countries, retailers hedge themselves against local risks.
On the other hand, real estate costs money. Maintenance and improving a large network of stores can easily eat into a retailer’s profits, no matter how well the overall real estate market is doing. And if a retailer owns lots of retail space, but they’re not using it to their advantage, they could be losing money.
One metric that can help you see how well a retailer is managing their space is sales-per-square-foot. Basically, sales-per-square foot is the average revenue a retailer earns for every square foot of sales space. For instance, if a company has 5,000 square feet of space and it earns $500,000 in a quarter, then the retailer could say they sell $100 of goods for every square foot of space.
Sales-per-square foot data can help you compare how well different retailers use their space to market and sell products. If one retailer has a higher sale-per-square foot than a similarly-sized retailer, then theoretically the first one is using their space more efficiently.
But be careful here: with the rise of e-commerce, sales per square foot data could be skewed. A company may have enormous e-commerce revenue. At the same time, they could generate a much smaller amount in its physical stores, giving them a lower sales-per-square foot number. The store itself could be using the space efficiently, but the retailer’s online sales are decreasing foot traffic.
For this reason, you should always look at other metrics alongside sales-per-square foot data, as you can better understand a company’ finances with multiple perspectives.
Mathematical metrics and data can tell you a lot about a company’s growth. But there’s one thing numbers can’t tell you: what it’s like to actually stop in the brick-and-mortar stores.
So take a field trip. Visit the retail stores you want to invest in. Pay attention to the storefront and display windows. Are they clean, well-organized, and properly lit?
Walk down the store’s aisles and get a good feel for the layout. If you were looking for a specific product, could you find it easily? Are the products lined up neatly? Is there a lot of foot traffic? Are shoppers more interested in discounted items than more costly purchases?
Pay attention, too, to the retailer’s employees. Did they greet you when you walked in? Did they ask you if you needed help?
Once you’ve visited the store, check third parties reviews to see if your experience matched the majority. If the reviews are overwhelmingly positive, and you found the store to be a good experience, there’s a good chance that retailer will thrive.
The retail sector can be fairly complex. With fierce competition among stores and consumer tastes changing constantly, retailers face numerous challenges that other market sectors don’t have to deal with. Before you start investing in retail stocks, here are some risks you should be aware of.
Retail stores have numerous components to analyze: from brick-and-mortar locations to inventory turnover to sales-per-store, all the way to cash flow statements, balance sheets, and P&L statements, you’ll definitely have your work cut out for you.
If you don’t have time to read and analyze financial documents, you’ll find being a successful retail stock investor a major challenge. One solution is to buy a retail stock-focused exchange-traded fund (ETF). Since an ETF can spread your money across numerous retail stores, you’ll bypass the risk of investing in only a handful. While you still want to know the retail stores inside your ETF, you won’t have the pressure of picking retail stocks yourself.
Over the years, we’ve seen a number of great stores end up in the graveyard of retailers. Toys R Us. Woodwards. Circuit City. Radioshack. The fact that a retailer can go from household name to sad story highlights one of the biggest risks in retail stocks: changing consumer tastes.
Take ecommerce, for instance. Before people shopped online, they shopped in malls. At that time, mall stores, such as Le Château, Dynamite and Garage, and Aldo, were lucrative investment opportunities. But, as soon as consumers no longer needed to go into physical stores, these retailers took a major hit.
It doesn’t take much to change the direction of a retail store. Throw in changes in fashion, market cannibalization, and a pandemic, and you’ll understand just how vulnerable they are.
Since retailers offer products and services we want but don’t absolutely need, retail purchases are often the first ones cut from a tight budget. When the economy is thriving, consumers are more comfortable buying, say, a Peleton. But when the market takes a turn for the worst, it’s much harder to justify discretionary spending.
Of course, people still need clothing, food, and certain discretionary expenses, such as electronics and books (depending on how stressful the recession is, cannabis could be on this list, too). But people will buy them less frequently and in fewer amounts. While many retail stores have proven resilient during hard times, others have not. Just look at the long list of retailers shuttered by the 2020 pandemic for evidence of that.
As a retail investor, you’ll do well to pick a handful of retail stocks that you believe will weather hard economic times. Retail giants, such as Canadian Tire or Loblaws, might make solid investing choices, as people tend to shop at these stores no matter what happens in the market.
Diversification is essential, too. You should pick stocks from numerous sectors of the retail industry, such as department stores, home improvement, cannabis, electronics, grocery, and clothing stores.
At the end of the day, no one knows which stores will become unnecessary spending during an economic downturn. For example, during the 2007 to 2008 recession, home improvement stores took a major hit, as the housing bubble had collapsed. During the most recent pandemic-induced downturn, however, home improvement stores generally did well, as people in lockdowns engaged in more home renovation projects.
Retail stores in the same sectors often sell the same, or very similar, products. This results in retailers competing constantly for the same customers through promotions, advertising, and more brick-and-mortar stores, all of which can have a major impact on share prices.
Ecommerce has also made competition more fierce. Now, retailers aren’t just competing with physical stores nearby. They’re competing with digital stores that may or may not have a brick-and-mortar presence.
Finally, retail stores have little say when federal and state enforce new regulations, such as minimum wage increases or mandatory lockdowns. When the retailer is forced to comply to new regulations, it can adversely impact the retailer’s profits.
It can be a lot of fun to invest in retail stores that you personally love and use. But be sure you’re well-informed about the retailer: you don’t want emotions alone to control your investing decisions.
Pay close attention to the retailer’s online and digital presence, both their ecommerce store and smartphone app, and visit their brick-and-mortar store to get a feel for how customers experience the store. Analyze sales growth, gross margin, and financial documents to see how the retailer is doing behind the scene, and examine the size of their store network to understand how real estate costs may help or hurt them.
As long as you focus on the essentials — such as a steady sales growth, high gross margins, and good holiday performances — you should be able to pick retail stocks with good growth potential and a promising future.
