The earnings season is in full swing with results from 350 S&P 500 members already out. But Retail-Wholesale sector earnings are yet to gain steam and will take center stage as the reporting cycle nears its last leg. The sector has gained 16.6% so far in the year and has comfortably outperformed the S&P 500 index that advanced 10.7%.

Per the most recent Earnings Outlook, about 39% of the total S&P 500 companies in the sector have reported results, wherein 62.5% beat earnings estimates and 68.8% surpassed revenue expectations. The report also suggests that the sector is expected to record top-line growth of 4% but is likely to witness earnings decline of 1.6% this season.

Thus, though investors are cautious, they are still looking to replenish their portfolio in a favorable economic scenario, with the GDP breezing past the $19 trillion mark. We believe that the encouraging economic data and friendlier fiscal and regulatory policies from the current regime bode well for the sector.

Sector’s Correlation with the Economy

The U.S. economy rebounded in the second quarter and more than doubled from the first quarter. A pick-up in consumer spending and an uptick in business investment in software, research and equipment boosted economic growth. Consumer outlays in particular improved on a steady job market and healthier household finances.

Per the Bureau of Economic Analysis, the real gross domestic product (GDP) “advance” estimate for the second quarter of 2017 improved at an annual rate of 2.6% compared with a 1.2% rise witnessed in the preceding quarter. This indicated that the sluggish start to the year was primarily due to seasonal factors such as adverse weather conditions and delay in tax refunds.

Consumer spending, which accounts for about two-thirds of the U.S. economic activity, increased 2.8% in in the second quarter buoyed by the strongest labor market in years. As per reports, the U.S. economy has created over 16 million new jobs since 2010 that has helped lower unemployment rate to 4.4%. In fact, the U.S. job market roared back to life in June, with a better-than-expected 222,000 job additions in the month.

The rebound in oil prices from all-time lows, improving labor market and gradual recovery in the housing market signal that the economy is on a recovery mode. These factors are favorable for retailers and definitely play a crucial role in improving consumer confidence, which rose to 121.1 in July from June’s reading of 117.3.

Changing Retail Dynamics

The retail landscape has been witnessing a sea change with the focus gradually shifting to online shopping. This transition in consumer shopping pattern is compelling retailers to fast adapt to the changes in the ecosystem. Retailers now have no option left but to keep pace with the changing retail scenario or get eliminated. They are now focusing more on enhancing their omni-channel capabilities, optimizing store fleet and restructuring activities. We note that U.S. retail sales fell for the second straight month in June (down 0.2%). But sales at non-store retailers inched up 0.4% sequentially and increased 9.2% from the prior-year period.

Likely Winners this Season

The Retail-Wholesale sector has not been an outstanding performer and identifying the winners is definitely a herculean task. Given the numerous stocks in the sector that almost always muddle one’s stock-picking prowess, the Zacks methodology could offer some relief. Our research shows that for stocks with the combination of a Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) and a positive Earnings ESP, the chance of a positive earnings surprise is as high as 70%. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.

An earnings beat boosts investors’ confidence in the stock, which is reflected in its rapid price appreciation. These stocks could therefore turn out to be great additions to your portfolio ahead of their earnings releases.

Dollar General Corporation (DG), which is expected to report its second-quarter fiscal 2017 results on Aug 24, is a solid bet with a long-term earnings growth rate of 10.6%. The Zacks Consensus Estimate for the quarter is pegged at $1.08. The company delivered an average positive earnings surprise of 1.4% over the trailing four quarters. This discount retailer has an Earnings ESP of +0.93% and a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.

We also suggest investing in Dillard's, Inc. (DDS), which is expected to release its second-quarter fiscal 2017 results on Aug 10. This fashion apparel, cosmetics, and home furnishing retailer has a Zacks Rank #3 and an Earnings ESP of +30.00%. The Zacks Consensus Estimate for the quarter stands at 10 cents. The company has a long-term earnings growth rate of 2.6%.

Another lucrative option is Nordstrom, Inc. (JWN), the fashion specialty retailer, which provides apparel, shoes, cosmetics, and accessories. The stock carries a Zacks Rank #3 and has an Earnings ESP of +3.28%. The Zacks Consensus Estimate for second-quarter fiscal 2017 is pegged at 61 cents. The company registered an average positive earnings surprise of 41% over the trailing four quarters and has a long-term earnings growth rate of 6%. The company is slated to report results on Aug 10.

Another stock that you may consider is L Brands, Inc. (LB) with a Zacks Rank #3 and an Earnings ESP of +2.38%. The Zacks Consensus Estimate for second-quarter fiscal 2017 is pegged at 42 cents. The company delivered an average positive earnings surprise of 11.1% over the trailing four quarters and has a long-term earnings growth rate of 11.3%. This specialty retailer of women’s intimate and other apparel, beauty and personal care products is slated to report its financial numbers on Aug 16.

Investors can even count on Costco Wholesale Corporation (COST) with a Zacks Rank #3 and an Earnings ESP of +0.50%. The Zacks Consensus Estimate for the quarter is pegged at $2.00. The company, which operates membership warehouses, has a long-term earnings growth rate of 9.5%. The company is scheduled to report its fourth-quarter fiscal 2017 results on Oct 5.

These five stocks are not the only ones to bet on. With the help of the Zacks Stock Screener and some permutation and combination, you can find out other retail stocks that have the potential to beat the market.

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