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The Retail (Special Lines) Industry is made up of a diverse group of merchants that sell a variety of products, from apparel and accessories to electronics to home decor. Specialty retailers generally manufacture their goods under a private label and sell them (sometimes along with well-known name-brand merchandise) through store chains in shopping malls, street locations, and outlet centers. In this sense, this group is held separate from large department stores and discounters, which form our Retail Store Industry. For the most part, this sector is mature and competition is fairly intense. Although the industry isn't categorically described as cyclical, it is sensitive to changes in the economy.

Not surprising, stock-price movement for these merchants often reflects operating performances, which are indubitably influenced by the macroeconomic environment, as well as market- and company-specific factors.

Economic Considerations

Investors should look to several measures of the economy when contemplating a position in this industry. Consumer confidence is an indicator that observers ought to examine. Defined as a key barometer of the public's sentiment on the economy and its direction, it plays a vital role in shaping the performance of retailers. On point, it may be helpful in forecasting future spending patterns, since the measure provides insight into the consumer-spending climate. An upward trend suggests that consumers feel upbeat and are apt to spend more freely. Conversely, a succession of falling readings usually implies consumers have grown pessimistic about the future. That, in turn, generally leads to less spending and more saving.

Of all the economic factors to bear in mind, consumer spending (or consumption) is of particular importance. It is a key factor underpinning economic growth, as it makes up roughly two-thirds of gross domestic product. Moreover, trends in consumer spending, as mentioned, have a substantial impact on the performance of this industry. Generally, spending advances during periods of expansion, with the rate usually slowing when growth is sluggish; there is the potential for a period of decline during an economic recession. Several underlying influences, such as changes to the tax code and the level of unemployment, affect consumer outlays.

Key Metrics

The financial reports of retailers include a few items that are specific to the industry. There are some key terms unique to retailing and the Retail (Special Lines) Industry that deserve explanation. Comparable-Store Sales (same-store sales, or simply comps) is an important year-over-year measure to which sector followers pay special attention. Nonetheless, this figure does not appear on the Value Line page. In contrast to Sales, which includes all receipts generated from new and established stores, Comp-Store Sales is a statistic that gauges a retailer's performance at stores open for at least one year and is typically released on a monthly basis. It enables investors to determine what portions of sales growth come from existing locations and from newly opened stores. This number will often appear in an analysts comment about a company.

Industry observers also take into consideration the portion of the top line that a retailer retains after the Cost of Goods Sold and other direct expenses associated with the production of merchandise. This falls under the Value Line heading of Gross Margin, and is expressed as a percentage. Pricing impacts Gross Margin. It is not unusual for a retailer to strategically use promotional pricing (or discounts) to drive customer traffic and sales. A good balance between full-priced selling and discounting is essential to keep the Gross Margin healthy. Relying too heavily on promotional pricing can have a detrimental effect. In general, the higher the Gross Margin, the better situated a retailer will be to cover fixed expenses, such as SG&A and interest costs, which are factored into the Operating Margin.

Number of Stores is another measure worth reviewing. It provides a perspective on the size of a retailer. This figure indicates whether a company is expanding or downsizing operations, and is useful in deciphering market position and clout. Too, specialty retailers disclose square footage, used to calculate Sales per Square Foot-a standard measurement of the success of store selling space. These metrics are of particular interest in those chains that are in their growth phase, since there is always an optimal balance between store openings and the realizable Sales per Square Foot. Indeed, deterioration in this regard may indicate that a merchant is expanding too quickly.

Trends in Inventory are also important. If inventory expansion outpaces sales growth, this can signal trouble ahead. Turnover, expressed as Sales divided by Inventory, shows how often items are sold and replaced. A high ratio usually indicates strong sales, whereas low turnover implies weak demand. Excess inventory often leads to deep discounting, which can hurt margins. On the other hand, too little supply can lead to lost sales and a potential decline in market share for a retailer.

Final Thoughts

No doubt, many factors, from consumer spending and fashion popularity, can affect the performance of members of the Retail (Special Lines) group. Investors ought to be aware that any single (or combination) of these issues might cause an increase in stock price volatility. As a rule of thumb, retail stocks tend to perform better when the economy is healthy. Retailers that successfully cater to shoppers' preferences commonly have favorable profit margins and possess attractive expansion potential; they typically prove the most rewarding as investment holdings.