Investing is a great way to build wealth, and the retail sector is one of the industries that has grown in the past years. Even though the coronavirus pandemic caused fewer people to go to stores in person, the retail sector evolved and more stores turned to e-commerce. Investors continue to purchase retail stocks because it offers the opportunity to own part of the business where they shop regularly, whether in person or online. But just because you like shopping at a specific store doesn’t mean it’s the best retail stock to invest in.
Keep reading to learn more about how to invest in the retail sector and the best retail companies to invest in.
What Does Investing in the Retail Sector Mean?
The retail sector consists of all kinds of stores that sell goods directly to consumers, with the most popular being Walmart and Amazon. When you invest in the retail industry, you’re buying shares of ownership from retail companies. Owning shares of individual retail stocks could provide you with capital gains if the value of the company rises, but you may also incur significant losses if the company’s value dips.
Who Should Invest in Retail?
The retail sector seems to grow every year, regardless of what’s happening in the market. The retail market has established brands that have been in business for years and emerging companies that would appeal to investors.
- You can invest in the retail sector if you’re interested either in growth or income stocks. Growth investors are much more interested in emerging companies they expect to grow in the years to come. These are companies that are not yet making profits, and investors speculate on the potential for fast growth that will ultimately lead to profits.
- On the other hand, income investors have an interest in established companies in the retail sector, which offers the potential to earn income in the form of dividends. In fact, the retail industry has several “dividend aristocrats,” including Target and Walmart.
- The retail segment is great for rookies and experienced investors. Although there are some nuances, it’s easy to understand and participate in this sector.
How to Invest in Retail
You can invest in retail stocks in the same way you would any other stock. All you need is a brokerage account, such as Public, TD Ameritrade, or E*TRADE. You’ll also need to know the stock ticker of the company you wish to invest in.
Investing in the retail sector can earn you some decent cash, but you may incur losses if you don’t know how to pick the best retail stocks. Here are some of the metrics that can help you choose strong retailers in the industry:
- Sales Growth– Retail companies that generate consistent revenue growth tend to be the best investment. Good companies to invest in likely have greater year-over-year sales growth.
- Earnings Growth — Even if a retailer generates revenue, it may not have reached the point of making a profit. Earnings can tell you if the company has any money left over after it’s paid all of its costs. In other words, the earnings of a company tell you if they made a profit, which is a sign of a better investment.
- E-commerce Sales vs. Brick-and-Mortar Sales — Today, retailers have their presence both online and physical locations. With e-commerce increasingly becoming popular, online sales have spiked. Retailers without a strong presence online will find it challenging to keep up with the competition.
- Balance Sheet Strength — When looking for the best retail stocks to invest in, go for companies with plenty of cash on the books and manageable debt on their balance sheet.
Performance During Key Seasons of the Year
Many retailers make huge sales during the holiday season, such as Black Friday and Christmas. During these key seasons, retailers offer lucrative promotions to bolster seasonal sales. A retailer with a solid performance during key seasons could indicate that it’s outperforming its rivals.
Best Retail Companies to Invest in
A few publicly traded retailers have established themselves as industry leaders, though whether you should invest in them depends on your personal circumstances. It’s best to talk to a financial advisor and research specific stocks to determine if investing in retail companies works for your portfolio. Below are some of the most popular retail companies for investors. These aren’t recommendations but just a starting point of potential companies to research and talk to your advisor about:
Amazon has spawned an online marketplace and every investor wants a piece of the pie. The e-commerce giant has a significant advantage with its Prime membership program, which currently has over 200 million members worldwide. Amazon Prime members have exclusive access to deals every day.
Amazon has also dominated the cloud computing industry through Amazon Web Services (AWS), a division that has largely contributed to its profits. The use of Alexa smart speaker devices, for example, has made it easy for retailers to order much faster.
In the first quarter of 2021, net sales rose 44% to $108.5 billion, compared with $75.5 billion in the same period last year. Additionally, net income increased to $8.1 billion as operating income rose to $8.9 billion from $4.0 billion year-over-year. These strong margins are the reason why Amazon generated a staggering $26.4 billion free cash flow over the last 12 months.
With a strong balance sheet, Prime membership program and cloud computing segments, Amazon is poised to perform well in the generations to come.
2. Home Depot
Home Depot is one of the largest North American home-improvement retailers. The company is known for its large warehouse stores serving both homeowners and professional contractors. The company performed exceptionally well in 2020 — reporting record-breaking sales of $132.1 billion in the fiscal year 2020 — as many people shifted from travel and entertainment to home improvement due to the pandemic. The strong momentum shows that Home Depot is positioned to succeed for many years.
3. Best Buy
The consumer electronics retailer is one of the appealing retail companies to invest in. Best Buy navigated through the pandemic extremely well compared to its rivals and reported 8.3% revenue growth in fiscal 2021. In the first quarter results of fiscal year 2021, the company saw $11.6 billion enterprise revenue compared to $8.5 billion in the same period the prior year. Domestic revenue increased 37% to $10.84 billion, while international revenue increased 23% to $796 million. Looking beyond the first quarter, Best Buy seems to be in a profitable spot.
Signs You Should NOT Buy Retail Stocks
Generally, investing in stocks has never been easier. But just because you have a basic understanding of the stock market doesn’t mean you will do well. In fact, not everyone should buy retail stocks. Here are four reasons retail investing might not be right for you:
1. The Market Doesn’t Always Make Sense
Though the retail market tends to be less volatile, some retail stocks plummet during recessionary periods while others thrive. The most important thing to keep in mind is that an economic downturn is normal. If the notion that the market won’t always make sense during a recession or a boom, investing in the retail sector may not for you.
2. You Stick Only to Stocks of Your Favorite Stores
Often, many investors buy shares from their favorite stores simply because they like shopping there. Just because it’s your preferred store doesn’t mean it’s the best stock. If you find yourself buying stocks from companies you like without taking time to do your research, it means you may be too attached to your favorite stores.
Identify the stocks you already know and do thorough research, but don’t forget to compare numbers unemotionally when making an investment decision. If you can’t do that, retail investing may not be suitable for you.
3. You Don’t Know How to Research Stocks
If you have no idea how to research retail stocks and make an investment decision, you shouldn’t be buying them. At the minimum, you should be familiar with the investing fundamentals, such as revenue growth, sales growth, same-store sales, and net operating income. You should also know metrics like:
- P/E ratio
- PEG ratio
- Free cash flow
Knowing them will allow you to incorporate them in your analysis to uncover the best retail stocks.
Additionally, you should stay up-to-date with the market trends in the retail sector — product launches, earnings announcements, and any other latest news of the stocks that interest you. If you can’t do all that, then you shouldn’t buy retail stocks.
4. You Panic in a Volatile Market
Since retail stocks are directly tied to consumers, they tend to perform well in good times and crash harder in bad times. If you panic sell when the retail market gets volatile, then retail investing is probably not for you.
Pros and Cons of Retail Investing
Like any other investment, retail investing has its own advantages and disadvantages.
- Growth in all economic cycles: The retail sector tends to be less sensitive to market disruptions and can thrive even in a recession.
- High dividends potential: Retail investing gives you the opportunity to earn dividends, as most established retail companies are dividend aristocrats.
- Faster growth: Retail companies have a much faster growth, which may eventually lead to profits.
- Smaller investments: You can invest any dollar amount to buy fractional shares of your favorite retail stocks.
- There’s no all-weather chain: Like any other sector in the stock market, retail stocks are also vulnerable to economic downturns.
The Bottom Line
Investing in companies you know can always be fun, given that you can enjoy capital gains when the market is good. To find retail stocks that fit your investing needs, focus on retailers with healthy cash flows, low debt levels, and strong competitive positions. This way, you’ll give yourself a chance to make money and build wealth.