The Investment U e-Letter: Issue #447
Friday, June 24, 2005

Short Sell Plays on Retail Stocks: How to Profit When the American Consumer Stops Spending
By Jeff Clark, special contributor to the IU e-Letter

[Editor's Note: I just spent a few days with Jeff Clark at a small investment conference on the Eastern Shore of Maryland. His track record is excellent, and his investment ideas are creative and easy to understand. So I asked him to contribute today's guest essay. Dr. Steve Sjuggerud, Chairman, Investment U]

I consider myself somewhat of an expert in the shopping habits of the American consumer

You see, my wife Gabriela is the perfect shopper… Perfect, because to her shopping is a hobby. Retail is her form of recreation. She loves to do it.

For as long as I can remember, one day each month, Gabriela leaves the home with a cafe latte in one hand and a fistful of credit cards in the other. Hours later, she returns, sans the cafe latte and a good portion of her available credit lines, with an SUV packed full of shopping bags from all the local retail outfits.

A few months ago, however, I began to notice an interesting trend… The number of shopping bags that I was being asked to carry upstairs from the garage was getting smaller. And my wife’s rush to get out of the house on “shopping spree day” was noticeably less enthusiastic.

Then, last Saturday, the unthinkable happened: the SUV arrived home empty.

“Where’s all the stuff?” I asked.

“I didn’t buy anything today,” she said.

Gabriela explained that she simply couldn’t find anything worth buying. In short, she was bored. Bored? BORED WITH RETAIL?

In all of the new stores, and in all of the new fashion lines, and in all of the new gadgets and gizmos, there was nothing worth buying. Since I view my wife as the ultimate gold medalist in shopping, this event caused me to ponder the following theory…

Could it be that the American consumer, rather than running out of money or credit, might simply get bored with spending? Could a bull market in boredom equal a bear market in “specialty” retail stores? And could this spell a profit opportunity through short sell plays on retail stocks?

If this theory holds true, then specialty retail companies-and their stocks-are in big, BIG trouble…

Just How Many Ionic Breezes Do We Need?

Consider what’s been happening with the stock shares of specialty retail giant Sharper Image (Nasdaq: SHRP) lately…

After crossing the ticker at just over $32 per stock share this past summer, SHRP has since been cut by two-thirds and is trading below $13.

“What happened?” you ask… Earnings. Or rather, lack thereof.

For years, Sharper Image has capitalized on the consumer’s desire for trendy, fashionable gadgets and gizmos, and generated record sales and earnings in 2004. In 2005, however, it appears that the consumer’s penchant for high-tech air filters and battery-powered nose hair clippers has diminished somewhat. Sales were down sharply during the first quarter and SHRP reported a loss of 30 cents per share.

Furthermore, they indicated the bloodletting would continue through the second quarter and informed analysts to expect losses in the range of 40 to 45 cents per share of stock. Worse yet, this business contraction is occurring at a time when the American consumer continues to spend at breakneck pace.

Of course, you could argue that the situation with Sharper Image is an isolated incident. Consumers simply grew bored with the company’s offerings and focused their spending elsewhere. But what do you suppose would happen if the consumer grew bored with spending on a larger scale? What if the consumer starts saving rather than spending?

In fact, as the experience of Sharper Image and my wife’s empty SUV illustrate, we may be close here…

Short Sell Plays on Retail Stocks: Selling Short Your Wife’s Skirt

Women’s clothing retail outfits may be the most vulnerable category in this class of stocks when you consider the short sell play…

At the risk of being labeled a chauvinist, and a sexist, and a whole plethora of nouns ending in “ist,” I am compelled to state the following general opinions…

• Women enjoy shopping
• Women make the majority of a family’s discretionary spending decisions
• Women like to buy clothes.

Consequently, if there is a change in consumer buying behavior, then it stands to reason that clothing retailers that cater to women will suffer the most.

You know the stores I’m talking about… the Ann Taylor’s, Chicos, ColdWater Creek’s, and J.Jill’s of the world. The stock prices of many of these specialty retail groups have more than doubled over the past year.

And rightly so, as the revenue and earnings growth of these companies are the highest in the industry. Furthermore, at current valuations (roughly 40 times trailing earnings and 25 times forward estimates), investors are betting on this trend continuing.

Don’t Count on It: This May Be the Time To Short Sell Specialty Retail Stocks

By almost any fundamental valuation, women’s retailers are quite richly valued. In addition, Wall Street analysts are completely in love with these companies and their stocks. These two characteristics are exactly what I want to see in any “short sell” candidate. The short sell (profiting from the fall in a stock’s share price) is how to capitalize on this trend.

While I like the trade, I’m not quite ready to sell women’s retailers short - yet. Currently, the price action of women’s retailers remains bullish. And one of the surest ways to lose money in the stock market is to sell short shares of a stock when the price action remains bullish. But we’re close.

In my newsletter, I wait until the downtrend is in place before I short sell, and therefore I’m more comfortable in the trade.

The Bottom Line

Women’s apparel retailers are one sector that will suffer when the American consumer finally pulls in the spending reins.

Again, I’m not willing to commit to the short sell side of the stocks just yet. But I’m close.

Women’s specialty retail stocks are expensive right now. Meanwhile, my wife is coming home with an empty trunk, and I know she’s not the only one. Chances are, stock shares of specialty retailers could surprise investors on the downside in the coming months. Selling short some of these stocks, once the timing is right, could be particularly profitable.

Good Investing,

Jeff Clark
Editor, The Short Report

Today’s IU Cribsheet

• Thanks to Jeff Clark for his guest essay in today’s IU e-Letter. Learn more about his excellent newsletter, The Short Report.

Good investing,

Steve

Related Articles:

To read more about short selling opportunities, check out:

• Short Selling Stocks: Is It Time?
• How to Cash In… Even When a Stock Tanks
• Shorting Stocks: The Truth about this Investing Strategy… and When It Makes Most Sense

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