Retail is a tough business.
This week, the retail sector got hammered, notably Macy’s and Nordstrom, which saw shares crash.
Macy’s stock fell 14% on Wednesday after reporting disappointing third-quarter results. After the market closed on Thursday, Nordstrom shares were down as much as 16%, as the company’s earnings widely missed expectations and its outlook for next year was also lowered.
And on Thursday, Twitter user Modest Proposal — a great Finance Twitter follow for people looking to learn more about how to think about investing, particularly media companies and stocks — explained succinctly why retail is a brutal business.
“Retail has high fixed costs, high working capital intensity, fickle customers, low barriers to entry,” they wrote, calling the sector a case study for the worst-possible business.
On Thursday, they added that this is something to remind yourself as an investor any time you think the sector looks “cheap.” This means that as, say, a multiple of earnings to share price, the sector looks relatively attractive against other investable opportunities.
But so the original point made neatly breaks down the elements of why retail is a brutal business.
As a traditional brick-and-mortar retailer, your fixed costs are numerous. You’ve got to have the physical space, inventory, personnel, and supply chain to keep the whole system running.
These costs are also variable over time — namely, all of these things tend to get more expensive. That means you need to keep shoveling profits back into the business to maintain your profit margins or market share. There’s your high-working capital intensity.
And as Modest noted, consumers are fickle. One day people want to buy Abercrombie, then next year it’s American Apparel, and then the year after that it’s something we don’t even know about yet.
The American consumer is a powerful force — consumer spending accounts for about two-thirds of GDP — but also a force that is hard to predict and harness.
So in retail, you’re basically making a four-sided bet that you can keep your costs low(ish), your inventory fresh, and your (hopefully growing base of) customers happy and stay nimble enough to stave off upstart competitors.
That’s a big bet.
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