Over the last few years, the outlook for retail has been uncertain at best, with 2022 not looking much better. However, despite the hardship caused by the pandemic, there have been some positives recently. The pandemic has opened the door for a long-overdue great retail reset that may help move many retailers into more stable and profitable positions than ever before. For example, a Deloitte study found that 58% of executives saw inflation as an opportunity to raise prices and improve margins. Others are rethinking their old buying and discounting cadences. With supply chain issues leading to fewer products to sell, some stores stopped offering promotions, thereby boosting profits.
Despite this, the retail industry still faces headwinds. The “Great Resignation” that started in 2021 with workers voluntarily leaving jobs has brought workforce issues to the forefront of industry discussions. Seventy percent of executives say labor shortages, especially in hourly wage jobs, will hamper retail growth in 2022. Turnover has always been an issue with these jobs, but it has accelerated even further because of the pandemic’s additional pressures on workers.
Supply chain issues originating during the pandemic persist today and will likely continue through 2022. One challenge with keeping stores stocked is consumer purchases being less predictable than pre-pandemic. In addition, consumers shop at a wider variety of retailers, including brick and mortar and e-commerce, which makes demand planning, inventory management and fulfillment forecasting more difficult.
Consumers are becoming increasingly reliant on technology and digital platforms. Due to this, many retailers are focused on expanding their e-commerce business, increasing digital marketing and adding automated checkout services.
Retailers face many challenges in the coming years that will likely last beyond the end of the pandemic. However, there are opportunities for retailers to adapt to their ever-changing environment. Like with many industries, technology provides a chance to automate brick-and-mortar businesses and expand online. In the coming year, meeting employee and consumer needs will be crucial for being a successful retailer.
Grading Retail Stocks With AAII’s A+ Stock Grades
When analyzing a company, it is helpful to have an objective framework that allows you to compare companies in the same way. This is why AAII created the A+ Stock Grades, which evaluate companies across five factors that research and real-world investment results indicate to identify market-beating stocks in the long run: value, growth, momentum, earnings estimate revisions (and surprises) and quality.
Using AAII’s A+ Stock Grades, the following table summarizes the attractiveness of three retail stocks—Kroger, Target and Walmart—based on their fundamentals.
AAII’s A+ Stock Grade Summary for Three Retail Stocks
What the A+ Stock Grades Reveal
Kroger has a Momentum Grade of A, based on its Momentum Score of 91. This means that it ranks highly in terms of its weighted relative strength over the last four quarters. This score is derived from an above-average relative price strength of 13.4% in the most recent quarter, 23.2% in the second-most-recent quarter and 14.6% in the fourth-most-recent quarter, offset by a below-average relative price strength of –10.8% three quarters ago. The scores are 85, 89, 42 and 91 sequentially from the most recent quarter. The weighted four-quarter relative price strength is 10.8%, which translates to a score of 91. The weighted four-quarter relative strength rank is the relative price change for each of the past four quarters, with the most recent quarterly price change given a weight of 40% and each of the three previous quarters given a weighting of 20%.
Earnings estimate revisions offer an indication of how analysts view the short-term prospects of a firm. For example, Kroger has an Earnings Estimate Revisions Grade of B, which is positive. The grade is based on the statistical significance of its latest two quarterly earnings surprises and the percentage change in its consensus estimate for the current fiscal year over the past month and past three months.
Kroger reported a positive earnings surprise for fourth-quarter 2022 of 23.5%, and in the prior quarter reported a positive earnings surprise of 17.6%. Over the last month, the consensus earnings estimate for the first quarter of 2023 has increased from $1.272 to $1.292 per share due to one upward revision. Over the last three months, the consensus earnings estimate for full-year 2023 has increased 0.6% from $3.806 to $3.830 per share, based on three upward revisions.
The company has a Value Grade of B, based on its Value Score of 30, which is in the value range. This is derived from a very low price-to-sales (P/S) ratio of 0.28 and a high shareholder yield of 5.0%, while the sector median shareholder yield is 0.0%. In addition, Kroger has a Growth Grade of C based on strong quarterly year-over-year earnings growth of 862.7%, offset by a poor five-year earnings growth rate of 1.2%.
The company has a Value Grade of B, based on its Value Score of 38, which is in the value range. Lower scores indicate a more attractive stock for value investors and, thus, a higher grade.
Target’s Value Score ranking is based on several traditional valuation metrics. The company has a score of 8 for shareholder yield, 21 for the price-to-sales ratio and 43 for the price-earnings ratio (remember, the lower the score the better for value). The company has a shareholder yield of 7.1%, a price-to-sales ratio of 0.74 and a 13.9 price-earnings ratio. A lower price-earnings ratio is considered a better value, and Target’s price-earnings ratio is just above the sector median of 12.7. The price-to-book-value ratio is 6.2, which translates to a score of 88.
The Value Grade is the percentile rank of the average of the percentile ranks of the valuation metrics mentioned above, along with the price-to-free-cash-flow ratio and the ratio of enterprise value to earnings before interest, taxes, depreciation and amortization (Ebitda).
A higher-quality stock possesses traits associated with upside potential and reduced downside risk. Backtesting of the Quality Grade shows that stocks with higher grades, on average, outperformed stocks with lower grades over the period from 1998 through 2019.
Target has a Quality Grade of A with a score of 92. The A+ Quality Grade is the percentile rank of the average of the percentile ranks of return on assets (ROA), return on invested capital (ROIC), gross profit to assets, buyback yield, change in total liabilities to assets, accruals to assets, Z double prime bankruptcy risk (Z) score and F-Score. The score is variable, meaning it can consider all eight measures or, should any of the eight measures not be valid, the valid remaining measures. To be assigned a Quality Score, though, stocks must have a valid (non-null) measure and corresponding ranking for at least four of the eight quality measures.
The company ranks strongly in terms of its return on assets (ROA) and buyback yield. Target has a return on assets of 12.9% and a buyback yield of 5.0%. The industry average return on assets and buyback yield are 4.2% and –0.5%, respectively. The return on assets indicates how profitable a company is in relation to its total assets. The higher the return on assets, the more efficient and productive a company is at managing its balance sheet to generate profits. However, Target ranks poorly in terms of its change in total liabilities to assets, in the 33rd percentile.
Walmart (WMT) offers shopping opportunities in both retail stores and through e-commerce and provides access to its other service offerings. The company offers an assortment of merchandise and services at everyday low prices. The company operates three segments: Walmart U.S., Walmart International and Sam’s Club. The Walmart U.S. segment is a merchandiser of consumer products, operating under the Walmart and Walmart Neighborhood Market brands as well as Walmart.com and other e-commerce brands. It operates in the U.S. The Walmart International segment includes various formats divided into retail and wholesale. These categories consist of supercenters, supermarkets, hypermarkets, warehouse clubs (including Sam’s Club), cash & carry and e-commerce through Walmart.com.mx, Walmart.ca, Flipkart.com and other sites. The Sam’s Club segment is a membership-only warehouse club that operates SamsClub.com.
Walmart has a Quality Grade of A with a score of 95. The company ranks strongly in terms of its gross income to assets and F-Score. Walmart has a gross-income-to-assets ratio of 58.6% and an F-Score of 8. The industry average gross income to assets is 23.1%, significantly worse than Walmart’s. The F-Score is a number between zero and nine that assesses the strength of a company’s financial position. It considers the profitability, leverage, liquidity and operating efficiency of a company. However, Walmart ranks poorly in terms of its return on invested capital (ROIC), in the 31st percentile.
Walmart has a Momentum Grade of C, based on its Momentum Score of 58. This means that it is average in terms of its weighted relative strength over the last four quarters. This score is derived from a relative price strength of –2.2% in the most-recent quarter, 3.0% in the second-most-recent quarter, –6.0% in the third-most-recent quarter and 14.6% in the fourth-most-recent quarter. The scores are 57, 59, 51 and 72 sequentially from the most recent quarter. The weighted four-quarter relative price strength is –2.2%, which translates to a score of 58.
Walmart reported a negative earnings surprise for first-quarter 2022 of –12.3%, and in the prior quarter reported a positive earnings surprise of 2.1%. Over the last month, the consensus earnings estimate for the second quarter of 2022 has decreased from $1.908 to $1.819 per share due to two upward revisions and 24 downward revisions. Over the last month, the consensus earnings estimate for full-year 2022 has decreased 5.0% from $6.748 to $6.410 per share, based on one upward and 30 downward revisions.
The company has a Value Grade of C, based on its Value Score of 50, which is considered to be average. This is derived from a very high price-to-book-value ratio of 4.28 and a price-earnings ratio of 27.6, which rank in the 81st and 70th percentile, respectively. Walmart has a Growth Grade of C based on a score of 43. The company has strong quarterly year-over-year earnings growth of 273.2%. However, this is the only growth metric that is above the industry median.
The stocks meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to perform due diligence.
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