3 Retail Stocks With Low-Risk Strategies
Out of the all the retail stocks to choose from, we have boiled down three low-risk strategies that dig out the very best options for sustained growth. With decades of continued growth in the consumer economy, you will want to be invested in these stocks.
Recently I was asked by a student as to which of Alibaba (BABA) or Wal-Mart (WMT) is the better investment. I was honestly confused by the comparison. This student referred a piece of news earlier this month stating that BABA has surpassed WMT as the largest retailer in the world.
I’m going to start by clearing up this misconception, and then I’m going to throw Amazon (AMZN) into the mix to compare these three retailers.
First, BABA Is Not Wal-Mart
Let’s be politically incorrect for a moment: China and Chinese companies like to fudge numbers. The original statement, comes from a filing with the SEC, not an earnings report. The statement says, “(BABA) has become the largest retail economy in the world as measured by annual gross merchandise volume (GMV) on its China retail marketplaces.”
That is, in its statement, BABA is claiming the sales of all the sellers on its marketplace as that of its own. This is a simple molding of reality, much like if I were to say I’m the richest person in my social circle, after including the salary of my spouse, my family, and my children.
The reported $500 billion in revenue includes three numbers:
- BABA’s true net sales, which are roughly $15 billion
- BABA’s customers’ true net sales
- BABA’s customers’ fake net sales
Because I brought it up, let’s discuss that last part for a moment. Having lived in China and Taiwan, and having dated a woman who made her money through online sales through AliExpress, I know firsthand that the Chinese online marketplace is more about reputation than anything. At the time, I had just created a skincare product on Amazon.com and started selling it with a brand new account.
Once my product started selling, my girlfriend’s response was shock. “Why would anyone buy an unknown product from an unknown seller?” In the AliExpress marketplace, you begin your business by buying your own product from fake accounts, leaving reviews for the product and for the seller.
Apparently, the strategy of fake sales is the only way to get your foot in the door. And afterward, the fake sales must continue. Much like share buybacks, you have to artificially raise the price of your brand to stay on top.
According to an article in the Financial Times, somewhere between 20% to 50% of the sales on AliExpress and Alibaba are fake. I believe it. Now, on to how this affects BABA.
BABA vs. AMZN
Unlike Amazon, which takes a large cut of each sale, BABA simply acts as a free broker for buyer and seller. If fake sales were being performed on Amazon.com, Amazon’s revenue would grow regardless. But Alibaba and AliExpress customers only use BABA’s assets to connect; sales are done “under the BABA table.” BABA actually profits from advertisements and product placements, not from taking a cut of sales.
Both companies are the winning online retailers in their respective markets. The main questions as to which investment is better depend on two factors:
- Which revenue scheme do you prefer?
- Which market do you want exposure to?
For question 1, you have the choices of commission-based, which is AMZN, or advertising-based, which is BABA. In both cases, a growing user base should grow revenue. AMZN grows proportionally in terms of sales; BABA can charge advertisers higher fees with more buyers.
For question 2, you should consider the economic issues of both the US and China. Both countries are in a relative slump, growth-wise. Still, the US economy remains a strong spender-based economy, and China’s spending middle class is still in its growth phase.
Overall, the revenue model is likely more important at this time. AMZN wins here, by gross revenue. However, when you look at margins and growth, you see BABA being the better buy. BABA’s gross margin is three times that of AMZN, and its y/y revenue growth is double AMZN’s. It also beats AMZN in net income, net income margin, and net income growth.
In BABA vs. AMZN, I say go with BABA unless you’re strongly averse to Chinese companies. Always remember: when investing in Chinese stocks, 50% more research is necessary than if you were investing in an American or Japanese company.
WMT vs. AMZN
As I pointed out at the beginning in this article, WMT and BABA are quite incomparable. Instead, we compared BABA to AMZN. But many investors do run the “WMT vs. AMZN” comparison.
One reason this comparison is made lies in fear – fear that online retailers will drive brick-and-mortar retailers out of business. For WMT, this is simply not a concern. Wal-Mart shoppers primarily use the store as a grocery store:
Nearly 60% of revenue comes from food sales. And WMT simply does not need to compete with AMZN in this market. For this reason, comparing WMT with an online retailer such as AMZN or BABA is rather invalid, and investors would benefit more from looking at the technicals of WMT vs. those of AMZN.
I prefer to start with a discounted cash flow (DCF) analysis to see whether the stock is mispriced or has a diverging trend respective of its DCF price. Here, we see WMT as slightly undervalued:
The “true” valuation should be at $75. We are at a rare point in WMT’s history. Since mid-2015, WMT’s stock has been underpriced. Prior to that, it was overpriced. Perhaps this explains the roughly sideways trend WMT has shown since the mid-2012s. What we are currently seeing is likely a temporary pullback until WMT reaches and crosses $75, making the stock overpriced again.
AMZN, however, is grossly overpriced:
We should expect a significant pullback soon unless AMZN starts posting strong earnings. Earnings will be posted on April 28th. A positive earnings report will keep the DCF line pointing upward, implying growth, and possible growth in the stock to even higher overvaluations. From a fundamental standpoint, AMZN is a stock to be avoided. But from a speculative standpoint, it’s at least a good candidate for a call option, which we will discuss below.
BABA, being a rather new listing on the NYSE, eludes a reliable discounted cash flow analysis. But the mere fact that BABA will be one of the world’s largest companies by 2020 – assuming it keeps growing at this rate – makes it another good speculative buy. Again, I recommend call options here.
RELATED: How to earn 7% a year from a specialty bank in as little as 5 minutes.
Why Call Options?
I recommend using call options for more speculative investments because of the inherent market risk and post-earnings risk. How a stock is subjected to market risk is quite easy to check: See how it performed during the 2008 market crash. Here, we compare WMT, AMZN, and the SPY during the drop:
Clearly, WMT had the best “market crash armor,” dropping to a degree of only half that of the general market. AMZN, however, fell a whopping 60%. It did, however, recover faster than the S&P 500.
So while WMT looks like a safe buy-and-hold, as judged by its market armor and its current undervaluation, stocks such as AMZN and BABA seem to be more susceptible to the influence of the general economy. For these two stocks, I recommend you use call options instead of buying the stock outright. This allows for all the upside but only a portion of the downside.
Plays follow.
AMZN
Because of the nose-bleed price at which it trades, AMZN makes itself an expensive options trade. That said, one call option mimics 100 shares of stock, so to avoid spending $60,000, you can simply buy a long-dated call option for a few thousand and get the same benefit of holding AMZN. Here’s my recommended call option:
BABA
BABA in considerably cheaper than AMZN, allowing for cheaper long-term calls. Here’s the option I would buy for BABA:
WMT
For WMT, you might just want to buy the stock outright. But, if you’re the speculating type and have faith in the discounted cash flow valuation, you might buy some incredibly cheap options with strike prices right at the DCF price of $75:
Buy 10 of these bad boys and mimic holding 100 shares of WMT for only $160. For every $1 increase in WMT, you’re looking at a $100 gain. That is, WMT only has to move upward $2 for you to gain 100% ROI on this trade.
Recently, Tim Plaehn, income expert with Investors Alley, met with the CEO of one of America’s fastest growing specialty banks, and what he told me just blew me away.
This bank didn’t take TARP money or other taxpayer bailouts–or any other bailouts for that matter–back in 2008 or ever.
This bank didn’t get tangled up in risky mortgage-backed securities, credit default swaps, stress tests, FDIC watch lists… you name it.
The CEO told Tim how his bank has been growing by leaps and bounds since even before the financial crash of 2008 and while impressive it’s not what stopped Tim in my tracks.
This specialty bank in America’s heartland is currently paying 7%.
He then shared with Tim exactly how his bank is able to pay so well and how everyday Americans (and Canadians!) can get in on this. Click here to find out.
Tim jotted down all of his notes and put them in this one report for you.
Click here for the full briefing that tells you exactly how and when to get started.
Note: Damon Verial is the author of this article. Coupling statistics with fundamental analysis, Damon has the goal of revealing to you the hidden patterns within stocks so that you may do what you wish with that information.
Category: Options Trading
