This past week, we were able to see the financial results for many of the major retailers. While most did exceedingly well, many suffered sizable stock price declines when they reported their fourth quarter results. In this week’s column, I will discuss the performance of the Consumer Discretionary sector, and the key differences between historical (actual) performance and expected future performance, and more specifically why investors must understand these differences to help them make better investment decisions.
The past two years (2008 and 2009) were dismal for retailers. For 2008, overall retail sales declined by 1%, and 2009 holiday retail sales increase a lethargic 0.4%. After the stagnant 2009 holiday season, MasterCard Advisors’ SpendingPulse™ reported a much better than expected holiday season for retailers with overall season-over-season growth of 5.5 percent. Excluding auto sales, holiday shopping in the 50 days before Christmas totaled $584 billion, again according to MasterCard SpendingPulse. The 5.5 percent increase over 2009 is the highest year-over-year increase since 2006.
The National Retail Federation had initially estimated growth of only 2.3 percent, which is the long-term, historical average annual growth rate for holiday sales. The group stated that recent stock market gains, income growth and personal savings built up during the recession helped boost consumer confidence and led to more sales.
Unfortunately, although estimates for retail sales for the holiday season have been surprisingly positive, a December 26th blizzard on the east coast put the brakes on what was expected to be brisk after-Christmas sales. Despite the blizzard, after-Christmas shoppers boosted sales at stores open at least a year 3.6 percent in the week ended Jan. 1, the International Council of Shopping Centers said in a statement on January 4th.
Most experts believe that spending that was expected for the after-Christmas period will not be lost, but instead will be pushed into January, as shoppers look for bargains. In fact, with total holiday gift card spending estimated at $24.78 billion, consumers still have plenty of buying power, and most experts believe they will continue to spend in the short-term. Retailers also expect gift card purchases to lead to additional spending during January.
U.S. retail e-commerce spending for the entire November – December 2010 holiday season reached $32.6 billion, a 12 percent increase versus 2009 and an all-time record for the season, (comScore, Inc.). By comparison, foot traffic increased over the previous year, but only by 1.8 percent for the season and 4.1 percent in the week ending January 1st, (ShopperTrak’ National Retail Sales Estimate (NRSE), based on the Department of Commerce data). Comscore reported that spending in November and December of 2010 totaled $32.59 billion, up from 2009's $29.08 billion. Black Friday (the Friday after Thanksgiving) and Cyber Monday (the following Monday), two of the biggest online shopping days of the year, had sales increases of 8.9% and 16%, respectively. Cyber Monday was the first billion-dollar spending day in history, and the first time Cyber Monday ranked as the heaviest online spending day of the year.
While the blizzard on December 26th and 27th certainly contributed to the shortfalls in sales reported by some retailers, the reality is, from an investor standpoint, expectations were extremely high for the sector.
Analysts continually increased their expectations for sales and earnings for stock within the Consumer Discretionary sector leading into the end of the year, which drove stock prices ever higher. In fact, the Consumer Discretionary sector was the top performer in the S&P 500, gaining 26% in 2010.
Some of the largest retailers, such as The Gap, Macy’s, Target, and American Eagle Outfitters did not meet analyst expectations, and their stocks paid a heavy price. Gap, the largest U.S. apparel retailer, showed a decline of 3 percent in same-store-sales, compared with the 2.4 percent average increase indicated by analyst estimates compiled by Retail Metrics Inc. Target, the second-largest U.S. discount chain, reported a same-store sales gain of 0.9 percent for December, compared with the 3.9 percent average estimate. American Eagle’s sales dropped 11 percent, versus the projection for a 1.8 percent decline. Gap’s stock dropped about 7 percent when they reported their sales figures this past week.
There were some noted winners for the holiday season as well. Abercrombie & Fitch Co. reported a sales increase of 15 percent, beating the average estimate of 10 percent.
Despite the impressive increase in retail sales during the holiday season overall, and despite strong same-store-sales (sales from stores open at least one year) for most retailers, many companies are falling short of analyst’s estimates. As a result, the stock prices of these firms, in most cases, are getting hammered when they report their sales figures. This underscores a key difference between actual, historical performance and future (analyst) expectations.
The reality is that analysts are human beings, with the same flaws as the rest of us. They get overly optimistic about the stocks that they follow, and can get caught-up in the hype and excitement, just as investors do. The term “herd mentality” certainly can be applied to the analyst community, meaning that those who follow a certain sector or industry group often follow the same exact line of thinking, all recommending the same companies with equal levels of enthusiasm and conviction. In these cases where every analyst is 100% convinced that the group will perform well, as happened with the Consumer Discretionary stocks this holiday season, it is next to impossible for any single analyst to publish anything other than stellar predictions, much less something outright negative.
One thing many investors have a hard time understanding is how a stock can sell-off significantly when they report seemingly fantastic news, such as strong sales and earnings. The reason this happens (quite often in fact) is that stocks trade on future expectations (usually supplied to the market by analysts) of performance, and not on actual, historical performance.
For example, analysts write and publish reports on a given industry or a specific stock that paints a rosy picture of the future. Based on the report, investors buy the stock (or stocks within the industry), driving the price up. As more and more analysts jump on the band wagon, publishing glowing reports on the stock (or industry), more and more investors also jump on board, creating a strong up-trend. Sometimes prices are driving up to such lofty levels, that even if the company reports exactly the performance that the analysts expected and wrote about in their reports, (sometimes even if they exceed those expectations), the stock will sell-off dramatically when the company reports their performance. If the company disappoints—reports performance that is anything less than what the analysts stated they should report—the stock, as we saw with The Gap and others, will get hit.
The tricky part is understanding what the longer-term expectations are for the company as well. If, for example, analysts expect the company to do really well this quarter and also expect them to do well (or even better) for the next quarter or two, and if the company meets or exceeds the current expectations, the stock may go up even more when the company reports results. In other words, we can’t automatically expect the stock to sell-off when results are reported.
If all of this sounds more like science fiction than science, believe me, you are not alone. I have been in the investments business for over 20 years, and I am still surprised on occasion. The key takeaway should be that investors should not place their faith in analysts or their reports. Instead, stocks should be bought and sold based on a combination of the fundamentals of the company and how, based on an analysis of those fundamentals and the expected long-term performance of the stock that should result from those fundamentals, fits within the risk tolerance and long-term investment objectives of the specific investor. In other words, stocks should only be bought if they are a good fit in the investor’s portfolio and are priced attractively, based on their true fundamentals, and should only be sold if they are no longer attractively priced, based on future expectations for long-term performance, and/or if they no longer fit within the investor’s long-term investment strategy, risk tolerance, and objectives.