Americans are likely to do more discount shopping this year as higher payroll taxes take a bite out of disposable income. A worker earning $50,000 a year in 2013 - close to the median US household income - is likely to pay about $1,000 more in taxes, as the Social Security payroll tax rises by 2 percentage points.
Payroll taxes are regressive - they apply only to wages up to a certain cutoff - $113,700 for 2012. This means they hit lower-income earners the hardest. In fact, the nonpartisan Tax Policy Center has said that US workers making $30,000 to $200,000 annually will end up taking a relatively bigger hit to their disposable income than those earning far more.
Combine less spending money with relatively high unemployment, and you can see why more people will be looking to penny-pinch in 2013. Off-price retailers, which sell name brands at steep discounts, have a history of benefiting during such lean times.
Currently, one of the most undervalued stocks on the market is Ross Stores (ROST), which operates more than 1,000 "Ross Dress for Less" stores and 100 "dd's Discounts" outlets located in strip malls.
Virtually all retail apparel stocks lost ground during fourth quarter 2012. But Ross shares were hit even harder due to concerns about its same-store sales.
In January, however, Ross proved the market wrong. Sales at Ross stores open for more than a year jumped 6 percent during the last five weeks of 2012, more than double what analysts had expected. Ross shares finally bucked the downward momentum, rising more than 15 percent from the recent low hit on Dec. 26.
During periods of economic turmoil, Ross tends to shine, as consumers shift their spending from higher-end stores to the discounters. While Ross could lose some of its existing customers once their budgets get pinched, other households with slightly higher incomes are likely to replace them.
Ross insulates itself from ever-changing fashion trends by buying a broad array of branded overstock, without over-committing to any particular inventory. Unlike its primary competitors, such as T.J. Maxx, Ross relies more on "packaway" inventory, which it buys at the end of a season and stores for a couple of quarters before selling. This allows Ross to better control inventory and pricing.
Ross' 500 buyers have ongoing relationships with about 8,000 vendors and pursue a strategy of "wider rather than deeper," opting for a changing variety of highly visible brands across a spectrum of products. That's the key to Ross' success. Ross' competitors either have more limited brand selection and/or are higher priced, including H&M, Target, Kohl's, Burlington Coat Factory, Big Lots, as well as online retailers such as Gilt Groupe and Overstock.com.
By the Numbers
Beyond its retail strategy, Ross boasts impressive fundamentals. The company's return on invested capital ((NASDAQ:ROIC)) has averaged nearly 38 percent over the past five years and is projected to continue tracking above 20 percent for the foreseeable future.
Ross' sales have risen 11 percent annually during the past decade, while earnings per share have grown almost 20 percent annualized over this same period.
Analysts expect Ross to post earnings growth of 23 percent for fiscal 2013, ending this January. Thereafter, earnings growth is expected to decelerate, though the consensus for fiscal 2014 is still a respectable 11 percent increase in profits.
The company has a strong balance sheet, with $625 million in cash at the end of October 2012, and just $150 million in long-term debt.
So Ross is in good shape to implement its ambitious expansion plans. Currently, Ross is significantly smaller than major competitor TJX Companies (NYSE: TJX), which does business as T.J. Maxx and Marshalls. Ross has about 1,200 stores vs. some 2,900 for TJX, showing that Ross has much more room to grow. Indeed, management hopes to more than double the size of the company, to some 2,500 stores, by the end of the decade.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.