Retail stocks rotate in and out of favor with investors rather easily depending on several factors, some of which are externally controlled whereas others are internal. Once darlings of the retail industry can just as easily become the most hated if the retailer miscalculates the types or style of goods consumers seek, an internal issue that can be turned around with the right management in place. The other factors are more external such as the state of the economy, which influences how willing consumers are to spend and what goods they desire. For instance during recessionary times, consumers tend to hold onto their cash and discretionary budgets decrease, hurting luxury retailers to the benefit of low budget retailers. The strength of the US dollar also impacts retailers both from a sourcing of goods standpoint (if retailers buy goods with US dollars from other countries, a weak US dollar will buy fewer goods) and from the translation effect on earnings from foreign operations. These and other factors impact the finances of the retailers so when deciding to invest in these stocks, investors need to analyze key financial ratios that drive the stock prices.
This article provides a guide of the most useful financial measures and ratios to track for the retail industry.
Retail Key Financial Measures and Ratios
The management of retail companies, like most other industries, provide guidance for earnings per share (EPS) and may even give a breakdown of operating profit or earnings before interest and taxes (EBIT) and revenues. Revenue guidance is generally provided in the form of same store sales or comps. These terms are used to describe sales as compared to prior year sales of stores open for that full time period. It is a comparability measure. For example, if Dollar General (DG), a low budget retailer provided comp guidance of 3% for December, it means the company expects sales in December to be 3% greater than sales in December a year ago for all the stores open for that full time period. This is important because it helps investors differentiate between sales growth from opening new stores and sales growth from existing stores.
Analysts also like to track foot traffic and ticket for retailers. Foot traffic or “traffic” refers to how many potential shoppers the retailer gets in its doors. Higher foot traffic generally leads to higher sales. Stores use gimmicks like sales or “grand openings”, but also promotions. For example, Kohl’s (KSS) has “Kohl’s Cash” which is a type of “coupon” that can be used during a specified time frame in which customers can apply the “Kohl’s Cash” against purchases. This “cash” is given to customers at checkout to be used at a later date, incentivizing them to come back to the store (increasing foot traffic) and buy more merchandise, generally leading to sales that exceed the “cash” amount. In other words it gets customers back to the store to spend more money!
Ticket is also measured. The higher the ticket, the more customers spend. Retailers want to increase the ticket. For example customer A buys a pack of gum, a low ticket item. Customer B buys a flat screen TV, a high ticket item. Retailers want to continually upgrade the ticket so customer C buys both the flat screen TV and the gum! Retailer’s primary way to increase tickets is through promotions.
Ticket, foot traffic and same store sales growth are all desirable, but not at the expense of operating earnings and margins. EBIT forecasts provide context to revenue growth. If retailers are so heavily promoting goods to increase traffic and ticket growth at the expense of profits, then the end result will not be positive. Comparing EBIT as a percent of sales, operating margin, provides useful information about the profitability of the growth initiatives. Operating margins should be compared on a year over year basis and against competitors. Actually all the financial metrics should be compared on a same store basis and within the same time period because seasonality has a big impact on retailers. The December holiday season tends to drive the highest foot traffic, ticket and comps. As a result, the calendar year (CY) fourth quarter produces the highest revenues while the CY first quarter tends to be produce the lowest. So comparing 4th quarter to 1st quarter would be meaningless but comparing 4th quarter this year to 4th quarter last year would provide the most useful analysis on the operations of the company.
The retail industry is measured based on how well the companies are able to grow sales in existing stores. Foot traffic and ticket data are used to forecast revenue growth because those with the strongest ability to profitably grow same store sales will receive the highest valuation multiple and attract investors.