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Analyst Blog

As another earnings season unfolds, it is time to reshuffle your portfolio but only to avoid adding stocks that have lower earnings beat predictability. Dodging these stocks will definitely minimize the risks to your portfolio. In today’s discussion, we are focusing on the Retail-Wholesale sector – one of the 16 Zacks categorized sectors –  in a bid to identify those stocks that do not fulfill our expected earnings beat criteria of a Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) and a positive Earnings ESP.

The Season So Far

Per the Earnings Outlook report as of Apr 19, out of the 57 S&P 500 companies that have come up with their quarterly numbers, approximately 75.4% have posted positive earnings surprises, while 54.4% beat top-line expectations. According to the report, earnings for S&P 500 companies that have reported are up 18.7% from the same-period last year, while revenues have increased 6.4%.

About 16.7% of the S&P 500 companies in the Retail-Wholesale sector have reported their results, wherein 42.9% beat earnings estimates, while 57.1% surpassed revenue estimates. While earnings rose 1% year over year, revenues climbed 2%. According to the report, the sector is expected to record top-line growth of 3.3% but is likely to witness earnings decline of 5% this season.

However, before jumping to the stocks, let’s have a look at all that is happening in the sector and how the same is placed in the changing economic scenario.

A Synopsis of Current Retail Landscape

The retail landscape has been undergoing a fundamental change, with technology playing a major role and the focus shifting to online shopping. This shift in buying pattern has forced retailers to come up with innovative ways to market their products. Retailers who have responded quickly to it by staying ahead technologically stand in good stead.

Parallel to this shifting retail landscape, the industry is facing major challenges from a still-strong U.S. dollar, volatile commodity costs and soft global economic environment. A strong dollar has resulted in lower spending from foreign tourists and impacted retailers with overseas operations. As a result, retailers are slashing prices and focusing on promotions to attract traffic.

Data compiled by the nation's largest retail trade group, National Retail Federation reveals that retail sales, excluding automobiles, gasoline stations and restaurants, are expected to increase in the band of 3.7–4.2% over 2016. Online and other non-store/online sales are expected to register growth of 8–12%. Kiplinger’s latest forecast shows that retail sales, excluding gasoline, are expected to jump 4.1% in 2017.

Sector’s Correlation with the Economy

The Retail-Wholesale sector has not been an outstanding performer but it still holds some promise, given the favorable economic indicators. Moreover, friendlier fiscal and regulatory policies from the current administration also bode well for the sector. However, we understand that the space is not fully immune to global uncertainties, which could limit growth. We note that in the past one year, the sector has registered an increase of about 8.9% compared with the S&P 500 that was up roughly 11.6%.

The recent rebound in oil prices, decelerating unemployment rate, and a gradual improvement in the housing market signal that the economy is on a recovery mode. These factors are playing a crucial role in raising consumers’ confidence. We expect this positive sentiment to translate into higher consumer spending. Personal consumption expenditures in the fourth quarter of 2016 improved 2%, while the U.S. economy expanded at an impressive rate of 2.1%.

However, we note that consumer spending inched up 0.1% in February this year, following a 0.2% jump in January. Further, retail sales declined for the second consecutive month in March. As per the Commerce Department, U.S. retail and food services sales fell 0.2% in March, following a revised down reading of 0.3% decrease registered in February. This indicates that the economy lost some steam in the first quarter. Retailers are definitely not going to like these economic numbers.

How to Identify Underperformers?

Surely, not all retail stocks are going to beat or meet expectations. There will be some slow coaches. We can identify them before they report by combining our proprietary Zack Rank and Earnings ESP system. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter. Our research shows that stocks with a Zacks Rank #4 (Sell) or 5 (Strong Sell) along with negative Earnings ESP have no or a very slim chance of outperforming estimates.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Beware of these 5 Picks

Stay away from Abercrombie & Fitch Co. (ANF - Free Report) , which operates as a specialty retailer. The stock holds a Zacks Rank #5 and has an Earnings ESP of -5.63%. The company is expected to report first-quarter fiscal 2017 results on May 25.

Texas Roadhouse, Inc. (TXRH - Free Report) is another stock to shun. This operator of full-service casual dining restaurants holds a Zacks Rank #5 and an Earnings ESP of -1.67%. The company is slated to come out with its first-quarter 2017 results on May 1.

Don’t let your portfolio fall prey to The Buckle, Inc. (BKE - Free Report) carrying a Zacks Rank #4 and an Earnings ESP of -8.82%. The retailer of casual apparel, footwear, and accessories is slated to report its first-quarter fiscal 2017 results on May 19.

Signet Jewelers Limited (SIG - Free Report) , which carries a Zacks Rank #4 and an Earnings ESP of -2.37%, also does not deserve a place in your list of stocks. This retailer of diamond jewelry, watches, and other products is scheduled to come out with its first-quarter fiscal 2018 results on May 25.

Another stock that you should forget for now is Urban Outfitters, Inc. (URBN - Free Report) , carrying a Zacks Rank #4 and an Earnings ESP of -12.50%. This lifestyle specialty retailer that offers fashion apparel and accessories, footwear, home décor and gifts products is scheduled to report its first-quarter fiscal 2018 results on May 16.

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