How to Make a Portfolio of Retailers

By Markets Fool.com

The retail business is notoriously challenging and competitive; however, it can also be very profitable for smart investors positioned in the best retail stocks. Companies such as Costco , TJX , and Nordstrom are solid candidates to consider if you are looking to build a portfolio of top-class companies in the buisness.

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Costco is the discount retail king
The retail industry is going through important changes, as new trends are emerging and the online revolution is transforming the way consumers search for and buy all kinds of products. However, some things will never change: Everybody loves low prices, and Costco has an extraordinary ability to deliver amazingly convenient prices.

Source: Costco.

Costco is the pioneer in the warehouse business model; the company makes most of its profits on membership fees, not on margins on prices. This allows Costco to sell its products at minuscule profit margins, or sometimes even at a loss, so the company can significantly undercut most competitors. Needless to say, this is a crucial competitive advantage in the business.

Costco has a remarkably loyal customer base; membership renewal rates are consistently above 85%, reaching an impressive 88% on a global basis, and 91% in big markets such as the U.S. and Canada in the last quarter.

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Management knows how to translate its competitive strengths and loyal clientele into superior financial performance for investors. Comparable sales excluding the impact of fuel price fluctuations and foreign exchange volatility increased by a strong 7% during the 31-week period ended on April 5.

By comparison, sales at Wal-Mart in the U.S. were flat during the last quarter, with comps at Sam's Club declining by 0.5% when excluding the impact from fuel prices. In such a mature industry like discount retail, one company's gains are usually the other one's losses, and Costco seems to be clearly taking market share away from the competition.

TJX for trendy bargain hunters
TJX is the biggest retailer of off-price home and apparel fashions on the world. Via brands such as T.J. Maxx, Marshalls, and Home Goods, the company operates nearly 3,400 stores the U.S., Canada, and Europe.

Source: TJX.

Size is a major advantage when it comes to cost efficiency and scale: TJX sources for products from over 17,000 vendors in more than 100 countries, and this allows the company to negotiate conveniently low prices with suppliers. The company sells its products at a pricing discount of between 20% and 60% versus typical retail prices.

Fashion retail tends to be particularly cyclical and volatile, but TJX has managed to deliver remarkably solid financial performance in the long term. Comparable-store sales have increased each and every year through the last 18 years, and earnings per share have grown in the double-digits over the last six years in a row. It takes a particularly strong business to deliver consistent performance in an industry in which most players typically see widely fluctuating sales and earnings.

In a sign of financial strength and confidence on the future, TJX has recently announced a big dividend increase of 20% coupled with a new $2 billion share buyback program to reward investors with capital distributions.

Nordstrom for top quality
Price competitiveness is a key factor to consider, but it's far from the only relevant aspect to keep in mind when building a portfolio of retail stocks. Merchandising, customer service, and onmi-channel presence are crucial success drivers in the industry, and Nordstrom knows how to execute in these decisive areas.

Source: Nordstrom.

Based on data from the American Customer Satisfaction Survey, Nordstrom has been ranked as the industry leader for customer satisfaction each and every year since 1995. The company has a satisfaction score of 86 for 2014, substantially above the industry average of 77.

Happy customers also mean happy investors when it comes to Nordstrom. Total sales during the quarter ended on January 31 were $4.04 billion, a healthy year-over-year increase of 9%. Nordstrom's comparable sales increased 4.5% during the quarter, with most of this growth coming from the online channel, as Nordstrom.com delivered a big sales increase of 19%.

Nordstrom Rack is another powerful growth venue for Nordstrom. Net sales in this segment grew 17% during the last quarter, to $899 million. Nordstrom Rack's comparable sales grew 3.2%, and the company opened 27 new stores in the last year, for a total of 167 Nordstrom Rack stores. Online sales in Nordstromrack.com and HauteLook jumped by an explosive 28%.

Blake W. Nordstrom, President and Director, explained in the last conference call how the company is leveraging its competitive strengths to deliver the right merchandise and a superior experience to customers:

Customers increasingly expect a personalized experience that merges the richness of stores with the convenience of online. We're uniquely positioned to serve customers through our focus on service, product and capabilities.

Even an average company can thrive when external conditions are favorable and competitive pressure is light. On the other hand, names such as Costco, TJX, and Nordstrom are doing exceptionally well in the notoriously harsh retail environment, and this speaks wonders about these companies and their management teams.

The article How to Make a Portfolio of Retailers originally appeared on Fool.com.

Andrs Cardenal has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale and Nordstrom. The Motley Fool owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.