Analyzing retail stocks has never been an easy task. Examine the financial statements of a retailer, and you'll quickly realize that the numbers are only part of the story. In order to determine a retailer's true success with consumers, it's necessary to visit its stores, check out the quality and price points of its merchandise, and even count the number of cars in the parking lot, before declaring a winner.

With the advent of internet shopping, the traditional form of retailer analysis is much more complicated. Read on to find out how to surf through this new world of online retailers.

The Online Retailer
Short for "electronic retailing", "e-tailing" refers to the buying and selling of retail goods on the internet. E-tailing has been around since the late 1990s, when retailers found that the internet could be an inexpensive and efficient way to peddle their wares. Today, online buying continues to grow in popularity; many of the purchases are big-ticket items like consumer electronics, cars and even diamonds.

The U.S. Census Bureau estimates that total U.S.ecommerce sales for 2006 were $108.7 billion, up nearly 25% from 2005. The use of the internet as a medium for retail sales is likely to gain in momentum as consumers go online in an effort to save time and energy. This trend will also benefit from the improved functionality and security of the web.

As a result of this movement, retail stock investors must update their jargon to keep up with the times. Where we used to buzz about the value of "brick and mortar" physical locations for traditional discount or department stores, we now refer to "click and mortar" to recognize that retailers must maintain both an online ("click") and an offline ("mortar") location. Retailers today rely heavily on online presence to maintain the quality and consistency of the brands they've worked so hard to create.

The Online Business Model
Does this mean that online shopping has forever changed the business model for retail companies? Well, yes and no. Shopping behavior online differs by product or service category, so it's important to distinguish what drives consumer choices. A consumer may, for example, spend time on Home Depot's website to research different lighting schemes, but will probably make a trip to the store to buy the chosen wall sconce.

For other products - a DVD, for example - a consumer is much more likely to steer her shopping cart exclusively online at, say, or Netflix, and eliminate the hassle of a car trip to the local Blockbuster video store. In the case of Home Depot, then, the retailer's online presence builds and protects its brand and customer loyalty by providing one more way to attract shoppers to its offline stores. In the case of and Netflix, however, Blockbuster may lose traffic permanently to its competitors, which could put its storefront business in jeopardy.

Find Winners, Avoid Losers
When you're thinking about the winners and losers in the click-and-mortar game, ask yourself whether a retailer is effectively using the internet as a means to attract shoppers toward its brands and into its stores. Better yet, ask yourself if you've found a retailer that has invented a new, more convenient and cost-effective way to deliver the same goods and services, perhaps by eliminating stores altogether and driving prices down. Both may end up being good investments, but the growth potential for the virtual store may prove far more impressive.

As today's retailers battle for both online and offline shoppers, they must still execute in the same mission-critical areas, regardless of the delivery channel. Among these key success factors are:

1. An easy place to shop and exceptional customer service
A successful retailer knows what customers want and consistently delivers the right merchandise at the right price, while also providing exceptional customer service. When analyzing a retail stock, try to evaluate whether the retailer's store environment - both its physical store and its online store - is attractive and easy to navigate.

A high-quality, speedy shopping experience builds brand loyalty and trust, thereby ensuring a retailer's long-term growth prospects. Do shoppers have to wait in long check-out lines, whether online or off? Consumers want a flawless shopping experience, whether they're pushing a metal shopping cart or a virtual one. Confusing layouts, lack of quality merchandise, insufficient inventory, poor service from the sales force (either on the store floor or in a customer chat room), and slow website applications can hurt top-line and bottom-line growth.

2. Driving market share and operating leverage
Retailers make significant investments in their stores, as well as in advertising and marketing campaigns. One of the largest costs borne by a retailer is inventory. To be profitable, retailers must carefully manage inventory levels by buying merchandise only exactly when needed ("just in time") and negotiating good deals from vendors. They must also keep labor and real estate costs low, all the while trying to bring more traffic through the doors. (To learn more about inventory, see Inventory Valuation For Investors: FIFO And LIFO, Understanding The Cash Conversion Cycle and Measuring Company Efficiency.)

A successful internet presence can help these retailers boost shopping volumes inexpensively by converting browsers into buyers, improving operating leverage and inventory turns. For retailers with online stores only, the opportunity is even greater. Virtual retailers are not required to maintain physical inventory or stores; consequently, theirs is a highly scalable business model. Lower operating costs mean retailers can reduce prices to drive more revenue volumes, which will turn inventory over faster; this will generate higher profitability, which will help the retailer grow into a bigger industry player and provide it with greater negotiating power with vendors. This will lead to lower operating costs, higher volumes, etc. - creating a "virtuous cycle" of growth.

Anything is possible in e-tailing. Retailers that understand and exploit the full potential of e-tailing can provide shoppers with a dynamic, easy and seamless journey both online and offline. Good web technology, great customer service and quality merchandise at the right price are the key ingredients to winning brand loyalty and capturing greater wallet share - and that is bound to improve any retailer's bottom line.

To read more on this subject, see Analyzing Retail Stocks.

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