Costco Wholesale Corporation (COST), Dollar General Corp. (DG): Now Is a Good Time to Buy Retail Stocks

The S&P Retail ETF is up around 35% year to date, compared to an approximate 20% rise in the S&P 500. The Retail index has been the best performing index based on the strength of the sector as a whole, as well as positive growth and projections from the individual companies.

Why the strength?

The retail sector is very unique as its success or failure is based on macro and microeconomics data, and other external factors. The data that best supports the retail industry include a lower household debt ratio, an increase in household net worth, a stable gas price, and a lower unemployment rate (compared to peak figures).

So who to buy?

Investors are left with many options when it comes to the retail sector, or alternatively, an investor can buy the ETF outright and have a diversified exposure to 98 retailers.

A true winner in retail

Costco Wholesale Corporation (NASDAQ:COST) should be a top pick for any portfolio looking for exposure to retailers. To start off, the company has a long term target of 1,200 clubs with a greater mix of international sales. In the company’s most recent earnings (3Q13), international comparable store sales were up a healthy 4% from previous quarter. The company has tons of cash, around $12 per share at the end of 3Q13, which gives it a cushion. In addition, same stores sales momentum remains healthy and its 5%-6% core appears to be sustainable.

Costco Wholesale Corporation (NASDAQ:COST) is one of the few if not the only large cap growth companies left in retailing and as long as traffic remains stable, Costco’s share price should continue trading at the higher end of the historical range. The company’s growth will continue to be driven by strength in small electronics, housewares, jewelry, and apparel. Hardlines and fresh foods comps increased in recent quarter and will also continue driving growth moving forward. Costco Wholesale Corporation (NASDAQ:COST) is also well positioned to continue capturing market share in the ever important online shopping market, as sales grew over 20% year over year in the U.S. and Canada.

Firing on all cylinders

Macy’s has been firing on all cylinders. The company sees same store sales at 3%-5% in 2013-2015. The popular retailer has a big opportunity to optimize inventory; turns at 3.1x are too low. From a financial point of view, a healthy free cash flow and leverage opportunities create impressive buyback power. Finally, a diversified product mix as well as demographic niche creates a competitive advantage that very few other retailers can claim.