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Inventory is a helpful tool for looking at the sales trends of a company, especially in the retail industry.

We ran a screen on retail stocks undervalued by free cash flow, with P/FCF below 15. We screened these stocks for those that have exhibited encouraging inventory trends year-over-year: increases in quarterly revenue exceeding increases in quarterly inventory year-over-year, as well as inventory becoming a smaller portion of current assets.

To help understand why these trends are positive, think of why the opposite trends would be negative. If inventory were growing faster than revenue, it would probably indicate that the company is having trouble selling its inventory. Of course, other explanations can exist such as changes in company policy.

Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned below. Analyst ratings sourced from Zacks Investment Research.

We also created a price-weighted index of the stocks mentioned below, and monitored the performance of the list relative to the S&P 500 index over the last month. To access a complete analysis of this list's recent performance, click here.

Do you think these retailers are seeing strong sales trends? Use this list as a starting-off point for your own analysis.

List sorted by market cap.

1. PetSmart, Inc. (PETM): Operates as a specialty retailer of products, services, and solutions for pets in North America. Market cap of $4.71B. P/FCF at 13.27. MRQ revenue has increased 6.98% ($1,487.55M vs. $1,390.54M y/y) while MRQ inventory has increased 2.54% ($638.29M vs. $622.48M y/y). Inventory/current assets has decreased from 57.01% to 54.84%, comparing 13 weeks ending 2011-07-31 to 13 weeks ending 2010-08-01. The stock has gained 23.9% over the last year.

2. BJ's Wholesale Club Inc. (BJ): Operates warehouse clubs in the eastern United States. Market cap of $2.80B. P/FCF at 14.25. MRQ revenue has increased 10.92% ($3,048.41M vs. $2,748.33M y/y) while MRQ inventory has increased 4.89% ($969.45M vs. $924.23M y/y). Inventory/current assets has decreased from 77.47% to 66.16%, comparing 13 weeks ending 2011-07-30 to 13 weeks ending 2010-07-31. The stock has gained 23.38% over the last year.

3. Saks Incorporated (SKS): Operates fashion retail stores in the United States. Market cap of $1.50B. P/FCF at 9.72. MRQ revenue has increased 12.99% ($670.18M vs. $593.14M y/y) while MRQ inventory has increased 2.73% ($689.22M vs. $670.93M y/y). Inventory/current assets has decreased from 68.93% to 60.82%, comparing 13 weeks ending 2011-07-30 to 13 weeks ending 2010-07-31. This is a risky stock that is significantly more volatile than the overall market (beta = 2.59). The stock is a short squeeze candidate, with a short float at 27.65% (equivalent to 9.41 days of average volume). The stock has had a good month, gaining 15.93%.

4. Zumiez, Inc. (ZUMZ): A mall-based specialty retailer providing sports-related apparel, footwear, equipment, and accessories. Market cap of $552.20M. P/FCF at 14.97. MRQ revenue has increased 14.85% ($112.21M vs. $97.7M y/y) while MRQ inventory has increased 7.24% ($84.39M vs. $78.69M y/y). Inventory/current assets has decreased from 40.92% to 35.33%, comparing 13 weeks ending 2011-07-30 to 13 weeks ending 2010-07-31. The stock is a short squeeze candidate, with a short float at 20.58% (equivalent to 8.75 days of average volume). The stock has gained 6.03% over the last year.

5. Medifast Inc. (MED): Engages in the production, distribution, and sale of weight management and disease management products, and other consumable health and diet products in the United States. Market cap of $233.91M. P/FCF at 8.70. MRQ revenue has increased 17.39% ($78.25M vs. $66.66M y/y) while MRQ inventory has increased 3.90% ($15.71M vs. $15.12M y/y). Inventory/current assets has decreased from 29.25% to 23.62%, comparing 3 months ending 2011-06-30 to 3 months ending 2010-06-30. This is a risky stock that is significantly more volatile than the overall market (beta = 2.09). The stock is a short squeeze candidate, with a short float at 30.49% (equivalent to 8.37 days of average volume). The stock has performed poorly over the last month, losing 10.41%.

*Accounting data sourced from Google Finance, all other data sourced from Finviz.

Source: 5 Undervalued Retail Stocks With Encouraging Inventory Trends