10 high-quality retail shares that are on the move

Stockopedia's Ben Hobson takes a look at 10 stocks in the retail sector that may be gathering momentum.

It has been a long, long time since stock market investors have had to concern themselves with the rate of inflation in the economy.

But we’ve started to hear a lot more about it in recent months. So what does the prospect of resurgent inflation really mean, and how might the latest figures influence the search for stock picking ideas?

A general rule is that over the long term, assuming corporate earnings rise as expected, investing in shares is a hedge against inflation. Good companies - especially those with pricing power - will be able to pass on rising input prices to their customers without much of a problem.

But in the short term, a rising rate of erosion in the purchasing power of money can be unsettling. The Bank of England’s main monetary lever to keep it in check is to raise interest rates.

But doing that essentially slows the economy down by calming consumer sentiment, which is negative for companies. Plus of course, rising rates makes bonds more appealing, which can also act like a drag on share prices.

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The rolling 12-month rate of inflation rose from 1.6% to 2.1% between April and May this year. And in June, that rose again to 2.5%.

Given that the Bank’s target is 2.0%, you can see why this trend is starting to turn heads. The question now is whether this inflation is just transient or the start of something a bit more serious. In practice, we won’t really know the answer until well into 2022.

But what we do know is what’s driving the current trend. According to the Office for National Statistics, prices for food, second-hand cars, clothing and footwear, eating and drinking out, and motor fuel have all risen in 2021 after falling in 2020.

In part, the reopening of the economy after lockdown has created a very understandable wave of spending. This is likely to be causing a rise in prices as businesses take advantage of strong demand.

What this means for investors

For investors, a focus on high quality and strong momentum in areas like retail could be a strong clue to finding shares well placed to benefit from this spending surge.

This week we filtered the retail sector using a dual-factor Quality & Momentum Rank. This looks for stocks with the highest overall exposure to strong financial and business quality and promising trends in both earnings and share prices.

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As you can see from the list, all of these shares have enjoyed positive relative share price strength this year. The forecast price/earnings (PE) ratios range from just 6x at car retailer Lookers (LSE:LOOK) to a more premium 28x at luxury watch retailer, Watches of Switzerland (LSE:WOSG) and 33x at the fast-growing online musical instrument seller, Gear4music (LSE:G4M).

Tallying with the evidence from the latest inflation stats, auto dealerships are a trend in this list, with Lookers, Marshall Motor (LSE:MMH) and Motorpoint (LSE:MOTR) all qualifying.

All eyes on inflation

The easing of Covid restrictions in recent months appears to have unleashed a wave of spending that is washing through several sectors of the economy. Consumer oriented stocks, particularly in retail, could be among the first to benefit from this rising demand.

After 18 months of turmoil, many companies in these sectors have had a very tough time. So from an investment perspective, it may well pay to focus on business quality and positive momentum to find those shares that are genuinely on the up and the UK gets back on its feet.

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