The Motley Fool: The Foolish Workshop, November 24, 1998

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Rising Margins Meet SSS

by Louis Corrigan (TMF Seymor)

Atlanta, GA (November 24, 1998) -- This week's Rising Margins screen offers another list of hot retailers.

Company, Sales, EPS, Same-Store Sales
American Eagle <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AEOS)") else Response.Write("(NYSE: AEOS)") end if %>, 42%, 115%, 29.4%
Ann Taylor <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ANN)") else Response.Write("(NYSE: ANN)") end if %>, 22%, 456%, 12.5%
Children's Place <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PLCE)") else Response.Write("(NYSE: PLCE)") end if %>, 51%, 136%, 18.0%
Electronics Bout. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ELBO)") else Response.Write("(Nasdaq: ELBO)") end if %>, 18%, 300%, 6.7%
Home Depot <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HD)") else Response.Write("(NYSE: HD)") end if %>, 24%, 30%, 7.0%
Lowe's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LOW)") else Response.Write("(NYSE: LOW)") end if %>, 19%, 32%, 5.0%
Men's Wearhouse <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SUIT)") else Response.Write("(NYSE: SUIT)") end if %>, 17%, 24%, 5.8%
Williams Sonoma <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WSM)") else Response.Write("(NYSE: WSM)") end if %>, 18%, 50%, 2.4%

Though retailers have had a volatile year given the recession fears playing into the recent market meltdown, most of these stocks have done well. As this list suggests, retailers with rising same-store sales (SSS) have a better chance of making the rising margins screen because they're able to leverage their fixed expenses. That's why the SSS trend can be used in conjunction with the margins screen, even as a leading indicator of improving margins.

For example, the Fool's Rick Aristotle Munarriz reported in a July Daily Double that the Children's Place was rebuilt after a perilous drop in same-store sales late last year suddenly reversed itself and comp-store figures turned up. The most lucrative time to buy into such a story is when one month's turnaround becomes a mild trend. The margins screen won't get you in at the beginning, but it should help you spot a potentially sustainable trend relatively early.

As soon as you see a trend and check out the company's financial health, the best thing to do is visit the stores and take a look around. The merchandise mix and the traffic in the stores should help you determine if something important has changed and whether the trend has legs. A sustainable trend should continue to be reflected in both the SSS and margins. What the best stocks confirm is that it makes sense to stick with your winners.

American Eagle Outfitters is a great example. A couple of years back, the company made a significant change in its approach, refocusing its merchandise on reasonably priced casual basics for the college crowd and broadening its offerings for young women. Choppy same-store sales in late 1996 resulted in a 12.2% drop in comps for the fourth quarter of the year ending January 1997. Same-store sales then popped up 3.3% for Q1 FY98, with margins soaring 250% on a 23% jump in sales for Q2. Here's what a turnaround followed by a great trend looks like.

Quarter  Sales   EPS     SSS
4Q98      -13%   -25%  -12.2%
1Q98       12%   -19%    3.3%
2Q98       23%   250%   11.8%
3Q98       33%   193%   23.8%
4Q98       25%   135%   16.5%
1Q99       64%     *    79.0%
2Q99       46%   700%   45.9%
3Q99       42%   115%   29.4%
* Gain of $0.24 reversing a loss of $0.16.

American Eagle reported results for the second quarter of FY98 on August 20, 1997. The stock was then at a split-adjusted $8.47, already up more than 100% from the beginning of 1997. Since then, however, the stock has soared nearly 600% as the good times kept getting better. Indeed, since the company reported earnings after the close last Wednesday, the stock is up 14% despite losing ground today.

Though every retailer faces different industry dynamics and all are ultimately dependent on the general health of the consumer, one could map a similar pattern for most retailers delivering fantastic capital appreciation. Improving same-store sales get reflected in the stock. They are then reflected in the margins. The cycle then continues for a couple of years, or in the very best cases, indefinitely.

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