About to Sell Your Apparel Stocks? Read This First

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Investors are likely familiar with the bearish thesis on apparel stocks: E-tailers are killing brick-and-mortar players, malls are being abandoned, and fast-fashion retailers like Zara are crushing the survivors. That's why companies like Aeropostale, American Apparel, Express, and The Limited all filed for bankruptcy protection over the past two years.

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However, investors shouldn't rush to sell all their apparel stocks. In fact, there's plenty of evidence suggesting that it's actually the right time to buy certain apparel stocks.

Don't throw out the babies with the bathwater

Some retailers deserve to be sold, but others have evolved and recovered. Gap (NYSE: GPS), for example, has rallied about 30% this year as the company shuttered non-performing stores, mimicked Zara's strategy of using analytics to drive designs, and invested in the growth of its stronger Old Navy and Athleta brands.

Wall Street now expects Gap's sales to rise 0.4% this year, compared to a 1.8% decline in 2016. Its earnings, boosted by store closures and better cost controls, are expected to grow 2% this year. Those aren't great growth figures, but they indicate that Gap isn't stuck in a death spiral.

Guess (NYSE: GES) has rallied roughly 35% this year as the retailer broke a multiyear streak of revenue declines with three straight quarters of year-over-year sales growth. Analysts expect its revenue and earnings to respectively rise 6.3% and 31.8% this year. Guess attributes that recovery to robust sales in Europe and Asia offsetting its ongoing declines in the U.S. market.

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And investors have perhaps been too hard on American Eagle Outfitters (NYSE: AEO), which slipped 8% this year despite repeatedly posting positive comps growth on the strength of its Aerie lingerie and activewear brand. Analysts expect AEO's revenue to rise 3% this year, but for its earnings to dip 10% on increased promotions before rebounding 3% next year.

The market is evolving, not imploding

The bearish thesis on apparel stocks also hurt retail REITs (real estate investment trusts), which own malls, shopping centers, and outlets. But if we look at the occupancy rates of some of these REITs, we'll notice that retailers are merely moving away from traditional malls and shopping centers toward outlet centers.

Tanger Factory Outlets (NYSE: SKT), which owns a portfolio of outlet centers, reported an impressive occupancy rate of 96.1% last quarter. Simon Property Group (NYSE: SPG), which owns a mix of premium malls and outlets, had an occupancy rate of 95.2%. Brixmor Property Group (NYSE: BRX), which mostly owns traditional shopping centers, had an occupancy rate of just 85%.

This indicates that bargain-seeking shoppers still go to brick-and-mortar stores, but they're visiting outlets more frequently than traditional malls. We see a similar trend with off-price retailers like TJX Companies, which has been outperforming many other brick-and-mortar retailers. This indicates that the brick-and-mortar market is merely evolving instead of imploding.

Cheap stocks with high yields

The sell-off across the retail industry resulted in higher dividend yields and lower valuations, making them worth a look in a frothy market.

For example, Gap stock rallied strongly this year, but it remains far below its all-time highs. The stock trades at 14 times earnings, which is well below the industry average of 23 for apparel retailers, and pays a forward yield of 3.1% with a payout ratio of 44%. American Eagle trades at 15 times earnings, and its forward yield of 3.5% is supported by a payout ratio of 52%.

Investors looking for an even higher yield should check out Tanger, which trades at 16 times earnings and pays a forward yield of 5.6%. As a REIT, Tanger pays out most of its taxable income as dividends, and it spent 87% of its EPS as dividends over the past year.

The key takeaways

I'm not sounding an all clear for the apparel industry, which still faces plenty of tough headwinds from e-tailers and fast-fashion challengers. But the mainstream bear thesis over-exaggerates the death of apparel retailers, and investors should be be selective with the stocks they sell and remain ready for buying opportunities.

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Leo Sun owns shares of American Eagle Outfitters and Tanger Factory Outlet Centers. The Motley Fool recommends Guess?, Tanger Factory Outlet Centers, and The TJX Companies. The Motley Fool has a disclosure policy.