Retailer Rotation: Sell These Two, Then Buy This One

by James Brumley | August 13, 2012 9:14 am

Why is it so easy to find a plethora of buy opinions on a stock when it’s undervalued, but all those prognosticators are nowhere to be found when it’s time to sell those very same names?

Not that I haven’t been guilty of the same, but by and large, when I open a can of worms with a bullish call, I like to close it, too.

So, I’m closing the can of worms I opened back on May 24 when I said Wal-Mart (NYSE:WMT[1]) was a buy-worthy name[2]. The stock has climbed from $63.73 then to $73.63 now — a 15% move. I know it’s not a huge gap up, but then again, it hasn’t been a huge amount of time. It doesn’t matter. Given where Wal-Mart is now, there’s more risk than reward in owning it.

Just to be clear, this isn’t a judgment call on the company. Whether you like Wal-Mart or hate it, there’s no denying the company’s revenue and sales growth. And, it would be nuts to think the growth trend is going to stop anytime soon.

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This is, however, a judgment call on the shares themselves. At the end of May, they were trading at a trailing P/E of 13.96, which is fairly palatable. Right now, however, they’re trading at a trailing P/E of 15.85, which still is palatable, but on the very high end of the valuation range Wal-Mart has left behind after the recovery began in early 2009 — P/E levels that we saw a couple of times in early 2009 before a pretty significant pullback for the stock. So, I’m more than a little uncomfortable now in seeing conditions that historically haven’t lasted long.

Oh — it doesn’t hurt my sell call that the stock is technically overextended as well, as the nearby chart illustrates.

While We’re At It …

While I haven’t made a buy call on Costco (NASDAQ:COST[3]), I’m still going to make a sell call on it. While it somehow has justified a P/E in the 20s since early 2011, even COST is pushing its luck at 26.6 times its trailing earnings.

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And like Wal-Mart, it doesn’t hurt my bearish call that COST also is overextended and spent the bulk of this past week making lower lows and lower highs. The stock also closed under its 20-day moving average line on Friday, cementing in place yet another dip like the many we’ve see since mid-2011 after shares got a little ahead of themselves.

Again, there’s not a thing wrong with the company. It’s just a lousy time to step into an investment, and a great time to step out of one.

Fill in the Gap

So with Wal-Mart and/or Costco now leaving behind a hole in your portfolio, how are you going to plug it up? Fear not — I’ve got an idea for you, and you don’t even have to leave the general merchandise retailing industry to find it. It’s Fred’s (NASDAQ:FRED[4]).

Unlike Wal-Mart or Costco, unless you’re in one of its geographical markets, you might never have heard of Fred’s. It’s a 679-unit chain of general merchandise stores, many of which also include pharmacy services. The retailer exclusively operates in the southeast United States.

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That’s not the important part to would-be investors right now, though. What’s important is how the stock appears to have jump-started a long-term rebound that has been brewing for years. Specifically, the chart has turned a string of lower lows before 2008 into a string of higher lows since 2008. Shares also have been chipping away at three horizontal resistance lines at $14.40, $15.30 and $15.80. Though it’s not over the last of those ceilings yet, it’s pushing the issue harder and harder every week now — a break above $15.80 is well within reach. Best of all, after a four-year buildup, that breakout should be explosive once started.

It’s not just a chart-based buy, however. Fred’s is quietly cranking up sales as well as the bottom line. Year-to-date sales are up 3.6%, mostly thanks to new store openings, and per-share profits are expected to be up 21% year-to-date when the retailer posts Q2 numbers later this month.

There’s no valuation pitfall, either. At 14.7 times its forward-looking income, FRED actually is cheaper than both of the bigger brothers mentioned above, on a trailing or a forward-looking basis.

Bottom line? It’s obviously not a complicated set of buy/sell decisions, but sometimes, the simplest analyses yield the biggest results. Fred’s just offers more reward than risk right now, while Wal-Mart and Costco don’t.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

  1. WMT:
  2. was a buy-worthy name:
  3. COST:
  4. FRED:

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