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After reading a few articles highlighting attractive retail/apparel stocks, we have decided to analyze the companies mentioned in these two articles based on their attractiveness from a valuation standpoint using AFG’s valuation model.  We have examined the expectations for sales growth embedded in their current prices using AFG’s Value Expectation interface, as well as provided four companies that we find attractive in this retail/apparel space. The first four companies listed in the table are from an article in MSN Money by Catherine Holahan that mentions companies thriving in the recession (performed well in March), The second four are from an article from The Curious Investor (SeekingAlpha.com) that give the author's picks for companies ready to take advantage of a retail revival when consumer spending returns to a more normal level. The final four stocks are companies that we find the most attractive in the retail/apparel space.

When analyzing the sales expectations for these companies, measuring the spread between a company’s VE sales growth expectations and what it has historically delivered will give you a good idea of which companies have the best chance of meeting or exceeding those expectations, and thus are more likely to outperform.

 Retail/Apparel Companies

*AFG’s Value Expectation allows us to understand the imbedded Sales Growth, EBITDA Margins, and Asset Turnovers a company has to deliver in the future to justify its current trading price. In theory and in normal circumstances, if the imbedded future performance is very conservative relative to the company’s historical performance, the stock is regarded as undervalued. The table displays the implied future sales growth of companies assuming their EBITDA margins and Asset turnovers stay at the 5 year median levels.

In Joel Greenblatt’s 2006 book, The Little Blue Book that Beats the Market, he presented his “Magic Formula” used in his hedge fund, Gotham Capital. Mr Greenblatt tested his formula between 1988 and 2004. The results were incredible, with only one down year, the magic portfolio would have returned 30.8% a year, against a 12.4% annual return for the S&P 500.

Mr. Greenblatt was a student of both Ben Graham and Warren Buffet and tried to include valuable insights from each investor in his “Magic Formula.” His Magic Formula was a screen that percentile ranked two variables: Return on Invested Capital (quality) and Earnings Yield (valuation). The idea is simple, buy the best companies at the best price. He also recommends one year holding periods, so we thought this would be a great time to get this list out. The Little Blue Book recommends selecting the top 30 firms from the “Magic Formula.” That formula ranks each company by variable and then puts a 50% weight on each. Below is a definition of each variable.

Variable 1: Return on Invested Capital = EBIT / (Net Working Capital + Net Fixed assets)

Variable 2: Earnings Yield = EBIT/EV

The table below shows the top 30 firms with their market implied sales growth expectations. Enjoy!