Retail stocks have excellent reward-to-risk ratios right now and I don't regret buying any of them in the last two years. Interestingly, I bought most retailers in the midst of painful sell-offs, which happened right after they reported quarterly results that missed analysts' earnings and comp estimates.
So far, retail stocks are the best performing stocks in my portfolio, but the time has not yet come to ditch retailers. My main retail investments at the moment are J.C. Penney (JCP), Best Buy (BBY) and Urban Outfitters (NASDAQ:URBN), all of which have the potential to move higher as long as consumer spending keeps growing.
I have singled out consumer spending as one of the most fundamental value drivers for retailers in the past -- which should be intuitive -- and occasional setbacks aren't going to change the narrative here. A big fuss was made yesterday after retail and restaurant sales for the month of June were reported. The Commerce Department said that sales at U.S. retailers and restaurants decreased 0.3% in June. The Commerce Department also revised its previous purchase estimate for May down to 1.0%. Both numbers were largely perceived as disappointments.
However, setbacks are part of the game. Rarely, if ever, will financial data move up or down in a straight line. Consumer spending has come a long way over the last few years and an improved job picture in the U.S. with an unemployment rate of 5.3% in June is the driving force for it.
Consumer spending has indeed risen dramatically since the end of the Great Recession and the current decline in spending is not worrisome at all. Just look at this chart to see why:
Source: Tradingeconomics.com
Best retail stock for 2015?
One of my top retail picks for 2015 and beyond is Urban Outfitters. The specialty retailer was thrown under the bus in May when it reported weaker-than-expected comps. As usual, missing comp estimates in the retail sector leads to great selling pressure, which ironically often affords contrarian investors with a buying window.
Besides the powerful theme of growing consumer spending that I just described and that supports retailers including Urban Outfitters in general, more analysts are turning real bullish on the stock: Jefferies upgraded the retail company from "Hold" to "Buy" yesterday and raised its price target from $36 to $50, quite a leap. A summary of Jefferies' reasoning behind the upgrade can be found here.
Jefferies is not the only investment bank that has a bullish outlook on Urban Outfitters. Cantor Fitzgerald reiterated its buy rating on URBN earlier this month and set a price target of $53 for the retailer's stock, implying 46% upside potential.
Urban Outfitters has been hammered
Urban Outfitters' surrendered most of its year-to-date gains when the specialty retailer missed 1Q15 comp estimates that led to a huge sell-off.
On the positive side, Urban Outfitters' stock now appears to have bottomed out.
Source: StockCharts.com
Your Takeaway
I continue to see more upside for Urban Outfitters since investors have turned too bearish on the specialty retailer too quickly in May. Consumer spending growth is a critical value driver for retail stocks and as long as the U.S. economy keeps growing, so will consumer spending. If Urban Outfitters surprises to the upside in terms of revenues and comps in the second quarter of fiscal 2015, URBN could become the center of attention once again. The stock retains a lot of recovery potential after falling out of grace. Long URBN, Long retailers.
