Inflation is back, and the markets are spooked. But — believe it or not — now is a great time to look for low-multiple retail stocks to buy.
The January Jobs Report came in last Friday and showed 2.9% wage growth, the best mark since 2009. This has investors concerned that inflation is already showing up in this full-employment economy before all the effects of tax cuts and fiscal stimulus have fully materialized. More inflation means more rate hikes. That means higher Treasury Yields and (typically) lower valuations on stocks.
That is exactly what has happened in the market over the past several days. Treasury Yields have spiked. Equity valuations have compressed. Stocks have been hammered.
But not all stocks should be treated equally.
When rates go up, stocks with big multiples are hit hardest as higher rates weigh on the value of their future profits. So during times of inflation, stocks with low multiples are the way to go.
Not all sectors should be treated equally either.
Retail stocks actually benefit somewhat from higher rates. If rates are going up, it’s because inflation is going up, which means wages are going up. And if wages are going up, it likely means consumers are spending more. That is a win for retailers.
So an investor looking to profit from inflation would do well to look for retail stocks to buy. Specifically, in this higher rate environment, I think investors should seek refuge in low multiple, big retail names.
Here are my 3 favorite low-multiple retail stocks to buy.
Low-Multiple Retail Stocks To Buy #1: Target Corporation (TGT)
My favorite low multiple, big retail name is Target Corporation (NYSE:TGT).
I’ve been pounding the table on Target stock for a while now. The valuation gap between it and peer Walmart Inc (NYSE:WMT) simply grew too wide in 2017. For the past decade, the two stocks have been given nearly identical valuations. But because Walmart supercharged their digital retail growth in 2017 with the Jet.Com acquisition, WMT stock got a huge multiple boost while Target’s multiple got cut.
As Target has built out its omni-channel retail capabilities and shown that its digital commerce business isn’t too shabby (four consecutive years of 25%-plus growth), TGT stock has bounced back. It’s up nearly 30% over the past 6 months.
With positive and accelerating comparable sales growth, margins that are starting to stabilize, and a huge grocery plus delivery push coming soon, TGT stock looked like a must-own name just a few weeks ago. And with rates now heading sharply higher, the attractiveness of TGT stock relative to other equities has only increased.
Target trades at just 14.5-times forward earnings estimates. That is much cheaper than the market’s 17.2-times forward multiple. So even if rates do rise, Target shouldn’t be affected all that much because it already has a sky-high earnings yield of nearly 7%.
Moreover, Target’s forward dividend yield of 3.4% is by itself higher than the 10-Year Treasury Yield (2.86%). If you combine Target’s earnings yield and dividend yield, that sum is more than triple the current 10-Year Yield.
Overall, Target is a good stock to own here. The growth narrative is only improving. It’s still undervalued relative to WMT. And the big dividend and earnings yields mean this stock’s valuation should be relatively immune to higher rates (for the time being).
Low-Multiple Retail Stocks To Buy #2: Lowe’s Companies, Inc. (LOW)
I’ve been bullish on the home building and home improvement space for a while. And one of my favorite plays in this space is Lowe’s Companies, Inc. (NYSE:LOW).
The home improvement space is a good place to be invested because it has secular demand. Cycles will cause demand to spike and drop, but overall, demand will remain persistent. This gives the home improvement space a sense of earnings longevity and security that is lacking in other industries.
From a valuation standpoint, Lowe’s offers investors the same wide sweeping home improvement benefits as Home Depot Inc (NYSE:HD), just at a lower cost (18-times forward earnings for LOW versus 22-times for HD). Also, LOW stock essentially has a hundred extra basis points of yield cushion against a rising 10-Year Treasury Yield compared to HD (5.6% versus 4.5%). So rising yields will cause HD stock to drop long before they hit LOW.
Also, with higher wages, consumers will likely start pulling the trigger on that big home improvement project they’ve been saving up for — yet another benefit inflation will bring to LOW.
In other words, I think the home improvement space is the right space to be in. I further think LOW is the better pick (over HD) given its higher earnings yield in an environment where earnings yield is starting to matter.
Low-Multiple Retail Stocks To Buy #3: Ulta Beauty Inc (ULTA)
My last pick for low-multiple retail stocks to buy is a name that has struggled recently, but could find its footing in a market where valuation matters against rising rates.
Cosmetics retailer Ulta Beauty Inc (NASDAQ:ULTA) was once one of Wall Street’s favorites. ULTA stock was viewed as pure play on the “Selfie Generation.” In that demographic, makeup is a hot selling product. That is why ULTA has rattled off huge comparable sales growth numbers for the past several years.
But the ULTA train came unhinged when competitors like big-box retailers upped their cosmetics game and started discounting items. Comparable sales growth cooled at ULTA. Merchandise margins fell. Profit growth dipped below 20%.
But ULTA is still a big growth name. Comps are still up more than 10%, while profit growth is still 19.5%. Over the next 5 years, earnings growth is expected to be roughly 18.6%.
Despite those big growth expectations, ULTA stock trades at less than 22-times trailing earnings. While that yield (roughly 4.6%) isn’t that much greater than the 10-Year Treasury Yield (2.86%), it also accompanies near 20% growth expectations. Indeed, ULTA stock is trading at a price-to-earnings/growth (PEG) ratio of under 1.2. The market is at 1.3.
In other words, ULTA is a big growth stock trading at a big discount. In a rising rate environment that will start to pressure some valuations, it’s reasonable to assume that big growth, big discount names like ULTA will outperform.
As of this writing, Luke Lango was long TGT, LOW, HD, and ULTA.