5 Retail Stocks to Beat Q4 Volatility

Volatility can be scary. Because stocks can move higher or lower for no apparent reason. Yet volatility creates the opportunities that watchful investors can grab to make outsized gains. So volatility can be your friend.

A Healthy Consumer

And when it’s a question of the fourth quarter, the consumer is likely to play a big role. Because the holiday season makes this the strongest/most significant quarter for retailers, which of course depend on the consumer.

As we have been talking about for several months now, companies are seeing rising input costs, rising wages and rising transportation costs that they need to be able to pass on to the consumer. So it all boils down to two things: sufficient inventory at retailers and the health of the consumer, which will determine how much of these more expensive things the consumer will buy.

Thankfully, the consumer has been strong throughout the year and remains so at this point, having absorbed government aid, having benefited from a strong stock market and having had limited opportunities to spend for quite some time now, leading to robust savings.

So we can see personal income continuing to edge higher for the third straight month, with disposable personal income also remaining in positive territory.

What isn’t so positive is the University of Michigan's preliminary reading of consumer sentiment for the U.S., which fell to 71.4 in October 2021 from 72.8 in September (below market forecasts of 73.1) with the gauge of current conditions dropping to 77.9 from 80.1.

Inflation expectations for the year ahead edged up to 4.8% from 4.6% while the 5-year outlook eased to 2.8% from 3%. The deterioration in sentiment was attributed to the Delta variant, supply chain shortages and reduced labor force participation rates, and on a more subtle level, to significantly lower confidence in government economic policies.

The other thing that contributes to a strong consumer is, of course, the labor situation. And in this respect, the declining unemployment rate is encouraging. At 4.8% and 7.7 million, the unemployment rate and number of people unemployed in September was a big improvement from the pandemic-hit March-April of 2020, although still lower than the 3.5% and 5.7 million in Feb 2020 (before the pandemic).

The labor force participation rate was more or less steady at 61.6% (1.7 points lower than Feb 2020). Participation doesn’t move around a lot, although it was roughly 2 points higher before the pandemic hit (it has lain between 62.5 and 63.5 for the last five years, barring the pandemic).

It’s also worth keeping in mind that around 4.5 million people are forced to work part-time, which is a kind of disguised unemployment, or "underemployment," at least. But since the number is only slightly higher than the 4.4 million in Feb 2020, this is mostly for reasons other than the pandemic. Rising wage rates are likely to get people back into the workforce sooner rather than later (although it may not happen this year).

A Strong Earnings Season

The first few earnings reports through Wednesday, October 13^th have set the tone for a better-than-expected earnings season. Of the 26 S&P 500 members that have reported so far, 80.8% have topped earnings estimates while 65.4% topped revenue estimates.

And while we were looking for 27% earnings growth on revenue growth of 14%, the first few reports average an earnings growth of 32.6% on 17.6% higher revenue. Overall, the S&P 500 is expected to grow earnings 42.8% in 2021 on 13.5% higher revenues.

Choosing the Right Stocks

These are the two most compelling reasons for optimism this quarter. But things like the debt ceiling and taper talk are adding incremental uncertainty and keeping investors on edge.

Inflation is a near-term positive for investors and generally supports growth stocks It’s also a near-term negative for consumers. Higher interest rates, on the other hand, have the opposite effect. So investing in growth stocks at attractive valuations may be just the way to go. That’s how I came to pick these stocks-

Kohl's Corp. KSS

This U.S-based department store chain that operates specialty department stores and an e-commerce site in the U.S. belongs to the Retail - Regional Department Stores industry, which is at the top 1% of more than 250 Zacks-classified industries.

The Zacks Rank #1 (Strong Buy) stock with both Value and Growth Scores of A is expected to grow 6,357.1% in the current quarter to end the year with 598.4% growth is also trading at cheap valuations.

The stock is currently trading at a price to next-year’s earnings (P/E) multiple of 7.7X, a price-to-sales (P/S) ratio of 0.38 and a price-to-earnings growth (PEG) ratio of 0.96. A P/E so far below 16 is rather cheap, since it’s well below the average P/E in our universe. A P/S and PEG of less than 1 indicates that investors are undervaluing the company’s sales and earnings growth, respectively.

Conn's (NASDAQ:CONN), Inc. CONN

Conn’s is a specialty retailer in Texas and Louisiana selling home appliances like refrigerators, freezers, washers, dryers and ranges; consumer electronics, TVs, VCRs, camcorders, DVD players, etc; as well as other home, office, gardening and other items. The Zacks Rank #2 (Buy) stock is a member of the Retail - Consumer Electronics industry (Top 6%).

Its Value and Growth Scores of A are supported by a solid growth profile and reasonable valuation.

Accordingly, the company is expected to grow its earnings by 228.0% in the current quarter and 6,562.5% this year.

It trades at a P/E multiple of 8.9X, a P/S of 0.46 and a PEG of 0.25, well below its median range over the past year.

AutoNation (NYSE:AN), Inc. AN

AutoNation, Inc. is the largest automotive retailer in the United States. The Zacks Rank # stock belongs to the attractive Automotive - Retail and Whole Sales industry, which is at the top 8% of Zacks-classified industries.

The company’s Growth Score of A is supported by the 177.1% expected earnings growth in the current quarter and 124.3% expected growth for 2021.

Its Value Score of A is supported by a P/E of 8.3X, a P/S of 0.35 and a PEG of 0.38. What’s more, it is trading below its median range over the past year.

Tilly's (NYSE:TLYS), Inc. TLYS

A specialty retailer in the action sports industry selling clothing, shoes and accessories, the #1 ranked Tilly’s is part of the Retail - Apparel and Shoes industry (top 8%).

The shares have an A for both growth and value.

They promise earnings growth of 466.7% this quarter to close the year with a phenomenal 4,358.3% increase from 2020.

And yet, they are priced cheaply at a P/E of 9.7X, a P/S of 0.62 and a PEG of 0.81. They also trade below their median value over the past year.

DICK'S Sporting Goods, Inc. DKS

The company operates as a major omni-channel sporting goods retailer, offering athletic shoes, apparel, accessories and a broad selection of outdoor and athletic equipment for team sports, fitness, camping, fishing, tennis, golf, water sports, etc. The Retail – Miscellaneous industry to which it belongs is in the top 34% of Zacks-classified industries.

The Zacks Rank #2 stock has Value, Growth and Momentum Scores of A.

Analysts expect its earnings to grow 90.4% in the current quarter and 110.6% this year.

Investors appear to be missing an opportunity here since the shares trade at a mere 12.9X P/E, 0.90X sales and 0.73X PEG. It is also trading below its median level over the past year.

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