How to Make a Killing in the Retail Sector

The stock market’s relentless rally over the past five months has produced a lot of big winners. Especially in the tech sector, which has soared on excitement surrounding artificial intelligence (AI).

Since trading below $400 in late October, AI memory device manufacturer NVIDIA (NSDQ: NVDA), closed above $950 three weeks ago. I recommended NVIDIA to my Personal Finance subscribers eighteen months ago when it was trading around $115.

I’m proud of that result, but I’ll be the first to admit that NVIDIA is an outlier. It has become the poster child for AI stocks, so everyone on Wall Street wants to own it. My timing was fortuitous.

In that regard, I am prouder of some of my other winning trades that involve stocks that nobody else wanted to own when I bought them. In those cases, it was good old-fashioned research that produced an outstanding result.

For example, last May I recommended Dick’s Sporting Goods (NYSE: DKS) to my PF Pro readers. At that time, DKS had recently nosedived beneath $125 after trading near $150 one month prior.

Dick’s was struggling to grow profitability early last year. An unusually large amount of “shrinkage,” or theft, forced the company to take a big write down on earnings during the first quarter.

Dick’s wasn’t the only retailer with that problem. Several other large stores including Target (NYE: TGT) also reported a similar issue with shrinkage.

As it often does, Wall Street decided to abandon the sector rather than take a thoughtful approach to how it was likely to play out. That’s when my PF Pro stock screener told me that it was time to stake out a position in Dick’s.

Priced to Move

In addition to recommending buying shares of Dick’s, I also suggested a call option trade. A call option increases in value when the price of the underlying security goes up.

That day, the call option for DKS that expires in January 2025 at the $125 strike price could be bought for $25. For that trade to be profitable, DKS would have to rise above $150 by the time that option expires.

Although that option still has another nine months to go until it expires, it has already quadrupled in value. Two weeks ago while DKS was trading above $220, that option was selling for more than $100.

That works out to a gain of more than 300% in just ten months. If you bought the stock at that time, the gain would be closer to 80%.

Either way, that’s a great trade. Especially when you consider that it involved a “failing” retailer that nobody on Wall Street wanted to own.

By the way, that example is not an outlier. Last August, I recommended a call option for Target. At that time, Target was trading near $124.

I suggested buying the TGT call option at the $120 strike price that expires in January 2025. That day, it could be bought for $25.

At the start of this month, TGT traded above $180. That made the intrinsic value of our call option $55.

And since this option does not expire for another nine months, the time premium pushed the total value of that option up to $60. That works out to a gain of 140%.

In both cases, timing was everything. I bought into both names while they were on the outs with Wall Street. That’s the key to profitable options trading.

Not so Great Expectations

As much success as I’ve had with retailers, I would not recommend them now. As it usually does, Wall Street has now bid them up to rich valuations.

If anything, I might buy a put option on them if they go much higher. A put option increases in value when the price of the underlying security goes down.

It’s not that I think Dick’s and Target are going to go through another round of shrinkage. They’ve learned their lesson and have their inventories under control.

My concern is that Wall Street will soon realize that it may have gotten too excited about them. After all, retailers are about as far removed from AI as you can get.

Also, retailers are entirely reliant upon consumer spending for their earnings. If consumer spending slows down for any reason, retailers will feel it the most.

In February, consumer sentiment fell for the first time since November. Next week, we’ll find out if it rose or fell even further in March.

We already know that the Consumer Confidence Expectations Index declined last month. Historically, it has been a reliable predictor of consumer sentiment.

If there is a slowdown in consumer spending, you can bet that Wall Street will start dumping retail stocks. At some point, those stocks will become oversold. And if that happens, I will be ready to snatch them up again.