Better Buy: J.C. Penney Company Inc. vs. Kohl's Corporation

By Brian Stoffel Markets Fool.com

Image source: Getty Images.

Continue Reading Below

A picture is worth a thousand words. And if you wanted to sum up what the world of retail has been like for investors since the Great Recession, the picture above pretty much says it all. While people do still like to buy some of their clothing at stores, the malls in which they exist are starting to look like ghost towns. That's spelled awful returns for investors in companies like Kohl's (NYSE: KSS) and J.C. Penney (NYSE: JCP).

JCP total return price data by YCharts.

In fact, while the larger market has essentially doubled over the past decade, these two have been big losers. But the thing about the stock market is that it's a forward-looking entity -- and such price fluctuations could make these stocks great picks today.

But which is the better buy? That's a tough question to answer, but we can gain some insight by comparing them through three different lenses.

Continue Reading Below

Financial fortitude

If you ever thought that companies are best when they return all of their cash to shareholders, the industry in which Kohl's and J.C. Penney toil should be evidence of the opposite. Companies who had cash on hand entering the Great Recession are still alive today. Those that didn't -- and instead had mountains of debt -- have largely gone out of business or been bought out.

Here's how J.C. Penney and Kohl's stack up in terms of financial fortitude.

Company

Cash

Debt

Net Income

Free Cash Flow

J.C. Penney

$183 million

$4,500 million

($322 million)

$87 million

Kohl's

$597 million

$4,500 million

$600 million

$1,600 million

Data source: Yahoo! Finance.

Keep in mind that Kohl's is currently valued at over three times the size of J.C. Penney.

But even after taking that into consideration, it's clear that Kohl's is far less fragile, financially speaking, than J.C. Penney. Kohl's has a much better cash-to-debt ratio, and has raked in the free cash flow (FCF) over the past year.

Winner = Kohl's

Sustainable competitive advantages

If I were forced to make investing decisions based on just a single factor, it would be this. A company's sustainable competitive advantage -- often referred to as a "moat" -- is what separates it from the competition. It is the unique "something" that makes customers identify with or keep coming back to a certain company.

Sadly, for both J.C. Penney and Kohl's, moats have been shrinking quickly in retail. In the past, the number of physical locations any store had -- along with their brand recognition -- provided enormous moats. If you had a store in a prime location, people would undoubtedly visit your store. And if you had lots of stores, you could benefit from economies of scale.

But very quickly, those strengths have turned into enormous liabilities. With the onset of e-commerce, brick-and-mortar locations became relative weaknesses instead of strengths. Nowhere is this more apparent than in the comparable-store sales (comps) of each of these companies.

Comps Over Time
Create column charts

Data source: Securities and Exchange Commission filings.

While J.C. Penney has been able to make laudable progress here over the past two years, much of it was possible because of the massive drops in 2012 and 2013. In reality, there are no winners here when it comes to moats.

Winner = Tie

Valuation

Finally, we have valuation. While this isn't an exact science, there are some straightforward metrics we can consult to give us an idea of how expensive each stock is.

Company

P/E

P/FCF

PEG Ratio

Dividend

FCF Payout Ratio

J.C. Penney

N/A

30

N/A

0%

N/A

Kohl's

13

5

1.4

4%

22%

Data source: Yahoo! Finance, E*Trade. P/E represents figures from non-GAAP earnings.

Here we have a clear winner. Kohl's is trading for a remarkably cheap price relative to its free cash flow, and it offers an outsized dividend that the company can easily continue to pay.

Winner = Kohl's

Final call = Kohl's

Kohl's is the pretty clear winner here. While J.C. Penney could certainly turn things around and end up being the better holding over the next five years, it's clear that Kohl's is the safer bet. While I personally don't own -- or intend to own -- either of these stocks, Kohl's is not only the safer bet, but it trades for a very low price and offers a very healthy dividend.

10 stocks we like better than Kohl's
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Kohl's wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of Nov. 7, 2016

Brian Stoffel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.