Why Dividend Investors Shouldn’t Ignore Retail Stocks

It’s a tough time for the retail sector. The industry struggled through a brutal first quarter, which included unusually harsh winter weather. Economic growth slowed down in the first three months of the year, which hurt retail, because the U.S. economy is heavily geared toward consumer spending.retail-stocks
The result is that first-quarter earnings out of the retail sector broadly disappointed. Sales and earnings results from major retailers like Kohl’s (NYSE: KSS), The Gap (NYSE: GPS) and Macy’s (NYSE: M) were not received well, and each stock fell significantly after reporting.
But it seems investors overreacted. While the bad winter suppressed growth, the pent-up demand was already causing sales to accelerate into the current quarter. And these companies still remain highly profitable and offer strong dividend yields.
Kohl’s, which reported first-quarter earnings on May 14, had $4.1 billion of total sales for the quarter, which was up 1% year over year. Comparable-store sales, which measures sales at stores open at least one year, rose 1.4%. Diluted earnings per share increased 5%, due to sales growth and a 17 basis-point improvement in gross margin.
In addition, Kohl’s financial position has improved over the past year. The company now has $1.1 billion in cash on the balance sheet, up 67% year-over-year. Meanwhile, it has a modest debt level. Its long-term debt-to-equity ratio is a manageable 46%.
Still, shares sank 13% after the earnings announcement, mostly because comparable sales missed analyst estimates by about $70 million.
For its part, Macy’s reported on May 13 that it suffered just a 0.7% decline in total sales for the first quarter, along with a 6% decline in diluted earnings per share. But again, the results missed analyst expectations.
Meanwhile, The Gap did slightly worse. On May 11, it reported that total sales fell 3% year-over-year in the first quarter. Gap, which will report its official first-quarter earnings numbers on Thursday, reported on May 11 that it expects $0.55-$0.56 in earnings per share for the quarter – a figure that fell below analyst estimates and sent shares down 4% the following day.
What the market is missing is that these three retailers remain solidly profitable with excellent cash flow. In light of the brutal headwind facing retail in the first quarter, investors should actually view their performance positively.
That’s because these stocks are solid value plays, with attractive valuations thanks to their stock price declines. And they are very good picks for dividend investors as well, because they pay market-beating dividend yields.
For example, Kohl’s pays a solid 2.7% dividend yield. Since it initiated its dividend in 2011, it has increased it by 15% per year.
The Gap increased its dividend by 4.5% in February this year, amounting to the sixth consecutive year of a dividend increase. The stock now yields 2.4%. Also, Gap approved a new $1 billion share repurchase plan the same day, which was double the previous share buyback authorization.
Along with its first-quarter earnings report, Macy’s increased its dividend by 15%. The stock now yields 2.2%. In addition, Macy’s increased its share buyback authorization by $1.5 billion.
Each of these stocks yields more than the S&P 500 as a whole. Plus, companies that increase dividends from year to year send a clear signal to investors that they can generate enough cash flow to reward shareholders – even when growth slows down. Dividend increases are a great sign of management’s confidence in what the future holds for their companies.
Separately, these three retail stocks are all cheaper than the market on a valuation basis. Kohl’s, The Gap and Macy’s trade for 15, 13 and 16 times trailing earnings, respectively. These multiples compare very favorably to the S&P 500, which trades for approximately 20 times trailing earnings.
As a result, dividend investors should view Kohl’s, The Gap and Macy’s as buying opportunities after their earnings selloffs. Their stocks are cheap, with higher dividends than the broader market, and their growth should come back now that warmer weather has returned in the U.S.

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