Ross Stores — 3 Pros, 3 Cons

There seems to no stopping the momentum of Ross Stores, Inc. (NASDAQ: ROST ).
Last week, the discount retailer posted a solid quarterly report, with earnings
up 23.5% to $1.26 per share and sales up 9.2% to $2 billion. Same-store sales
increased by 5%. For investors, Ross Stores certainly has been a winner. Keep in
mind that the compound annual rate of return was 51% for the past three years.
ROST shares are up 37% alone this year. But can the good times continue for Ross
Stores? Here's a look at the pros and cons of ROST stock: Pros Strong Business
Model: The company has two brands in the off-price retail category for apparel
and home accessories: Ross Dress for Less and DD's Discounts (which launched
in 2004). The focus is on providing top-quality, in-season merchandise. Yet the
stores are able to offer discounts of up to 60%. This is possible because of a
strong merchandising organization that buys a majority of the items directly
from manufacturers. The company also focuses on fewer categories and emphasizes
closeout products. Cost Discipline: This is a high priority at Ross Stores. The
company continues to invest heavily in new technologies and logistics systems.
Another key has been improved inventory management to reduce overstocking, which
can be costly. During the latest quarter, Ross Stores saw a 45-basis-point
increase in operating margins to 10.9%. The main reason was a 40-basis-point
drop in selling, general and administrative costs. Financials: They are
top-notch. During the first nine months of 2011, Ross Stores generated $413.7
million in operating cash flows. This should provide enough resources to
continue to grow operations as well as pay dividends and buy back ROST shares.
Cons Competition: It's intense. Ross Stores faces pressure from rivals like
Wal-Mart (NYSE: WMT ), Target (NYSE: TGT ) and Kohls (NYSE: KSS ). Even Internet
providers such as Amazon.com (NASDAQ: AMZN ) are a factor. Expansion: So far,
Ross Stores has stores in only 27 states, with a focus on the West and South. So
to grow, the company will need to branch out. This will mean ramping up
marketing expenditures and dealing with entrenched competitors. Holiday Season:
Because of the continued slow economy, the retail industry is likely to continue
offering more promotions and deeper discounts throughout the season. This could
pull consumers away from operators like Ross Stores. Verdict So far this year,
Ross Stores has repurchased 4.5 million shares, for a total of $343 million. The
total amount authorized is $900 million. Ross Stores' market opportunity
continues to look attractive. Total sales for the largest off-price retailers
increased 8% in 2010 and 7% in 2009. This compares favorably to total national
apparel sales, which came to 2% in 2010 and a 5% drop in 2009, according to the
NPD Group. When you also take into consideration that ROST stock is selling at a
reasonable valuation of 16 times earnings and even has a 1% dividend yield, all
in all, Ross Stores pros outweigh its cons. Tom Taulli runs the InvestorPlace
blog " IPOPlaybook ," a site dedicated to the hottest news and rumors about
initial public offerings. He is also the author of "All About Short Selling"
and "All About Commodities." Follow him on Twitter at @ttaulli . As of this
writing, he did not own a position in any of the aforementioned stocks.