High ranking retailers: Where to look for the best quality stocks on the high street

News that Mike Ashley’s Sports Direct group is weighing a bid for the troubled retailer Debenhams doesn’t come as much surprise. With a 29 percent stake, Ashley is Debenhams’ biggest shareholder, but the group’s fate is far from clear. Debenhams is labouring under sizeable debt (among other problems) - and its lenders could eventually end up calling the shots (whether Ashley likes it or not).

Debenhams is an extreme case but it’s symptomatic of the problems faced by a number of UK retailers. Traditional bricks and mortar stocks have long complained about the challenges of high rents and margin pressures caused by fierce online competition. Investors in the sector are well versed on how these factors can destroy margins… and even whole businesses.

One of the longest retail deaths in recent years has been HMV, the music and film chain. Back in 2013 the group slipped into administration and the PLC was liquidated a year later. But part of HMV lived on and some of its stores were acquired. But the new outfit went bust again last year, partly because it still couldn’t negotiate itself out of expensive store leases.

Meanwhile, news of struggling chains (both private and public) either attempting turnarounds or sinking completely, still make headlines. Among them have been the likes of New Look, Toys R Us, House of Fraser, Marks and Spencer, Patisserie Valerie (a fraud), Maplin, Carpetright, Homebase and Mothercare.

Another recent bust-up has been Julian Dunkerton’s effort to get himself back in control at the fashion retailer Superdry. Since stepping back from the business last year, Dunkerton has watched the chain’s valuation tumble from around £1.4bn to around £400m. But he and co-founder James Holder still hold a 29 percent stake. Dunkerton is keen to press his own strategy back on the business, but the board is so far saying no.

But aside from these examples, is it all bad news?

Look at the share prices of some of the best known quoted retailers in the stock market and you’ll find a mixed picture. It’s clear that in some cases, retailers have performed very well over the past year. In fact, investors in predominantly online firms like Boohoo.com and Asos, will vouch for the fact that retail stocks can deliver decent returns.

There are currently 51 stocks quoted in the “Specialty Retail” and “Diversified Retail” industries of the London Stock Exchange. As well as high street names, those groupings include car dealers, which have a slightly different investment profile. As for the rest, I’ve pulled together some of the highest ranking stocks based on their exposure to the Quality, Value and Momentum factors that we calculate with the StockRanks. In each case, the higher the ranking position (up to 100) the higher the exposure to the factor. The full screen is here.

Some of the better performing shares here include the likes of Dunelm, Shoe Zone and JD Sports. Others like SCS, Next and WH Smith have also managed to keep ahead of the market during the past year.

Others have had a harder time. The low Momentum Rank at Halfords points to a pretty dismal share price performance and earnings forecast downgrades over the past year. Its high quality, high value exposure puts it very much in Contrarian territory based on our StockRank Styles - but January’s profit warning was a painful blow to its price. Don’t forget that you can read our Profit Warning research here.

Together, these stocks have the best blends of quality, value and momentum right now. But you can see from the individual ranking scores that most rate pretty well for their quality. As a result of being high quality, they tend to attract higher valuations, which is why the Value Ranks are generally more modest. Striking a balance between quality and value is precisely the kind of “Warren Buffett approach” to investing that can pay off handsomely well into the future.

Incidentally, I tagged on Debenhams to the list. Its low quality, low momentum ranking scores point to something a bit different - the classic signs of a value trap.

The future for retail investing?

Take a look at the financial headlines and you’d be forgiven for thinking that UK retail is a sector in peril. Expensive leases, margin pressure, online competition and even Brexit are reckoned to be serious threats to some of the high street’s best known names.

But it’s also true that retail has been the source of some brilliant success stories in recent years. Investors have made a lot of money from this sector and new names continue to join the market.

Businesses that are out of touch with customers or are hanging on to outdated models have faced serious problems. But those that are well positioned, know their customers and adapt to changing buyer trends have been some of the best performing stocks in the market. It could well be an opportunity for investors prepared to roll up their sleeves and have a closer look.

Photo by Justin Lim on Unsplash