Rating The Retailers

Stocks to own as the nation's big stores prep for earnings season.

The holiday season of 2009 could still bring cheer to the equity market. Starting with Wal-Mart on Feb. 18, the big chain and department stores will turn in quarterly financial results, and Citigroup analyst Deborah Weinswig thinks Wall Street is underestimating profits and overestimating how conservative stores will be with their 2010 forecasts.

Not that Christmas was an unmitigated success story for everyone. Home Depot ( HD - news - people ) continued to suffer from the construction collapse with sales at existing stores down 4%, according to Weinswig. Still, that would be better than the 5% drop Wall street is predicting. She also thinks Home Depot scored higher margins in the last three months of 2009 and big-ticket purchases started to rebound, a good sign for the rest of this year. The home-improvement retail chain drew a Morgan Stanley analyst earlier this week. (See "Home Depot Heats Up.")

Department store Nordstrom ( JWN - news - people ) has already reported same-store sales, up 6.9% for the fourth quarter and well over the company's own forecast. Weinswig thinks Nordstrom will also surprise investors with net profits of 88 cents a share, 10 cents better than her analyst colleagues are calling for.

Though consumer spending is still in the doldrums, retailers managed some smart moves to preserve their businesses last year. They started planning for the holiday season when the financial crisis was still wreaking havoc in the economy and bought less merchandise, which resulted in fewer discounts designed to offload excess inventory, likely padding margins for the fourth quarter. Corporate profits are also still getting a boost from the cost-cutting measures many shops undertook when the future looked its bleakest.

You can only cut so far though, so investors will be paying most attention to retailers' forecasts for the year. Weinswig sees growing same-store sales thanks to a recovery in the broader economy, though she expects the companies to remain cautious with their estimates. She's predicting over-consensus earnings at Target ( TGT - news - people ), J.C. Penney ( JCP - news - people ), Macy's ( M - news - people ), Kohl's ( KSS - news - people ) and BJ's Wholesale Club ( BJ - news - people ).

Even with an upbeat earnings season, it's not clear how much more cheer investors can expect to get out of retailers. The SPDR S&P Retail ETF ( XRT - news - people ), which tracks the sector, is already up 75% in the past year.