TJX Profiting from Income Inequality

Those who doubt that income inequality is a real phenomenon need to take a look at TJX Companies (NYSE: TJX). For those you unfamiliar with it, TJX is the operator of discount department stores; T.J. Maxx, Home Goods, Marshalls and Sierra Trading Post.

Revenues at TJX increased by $8.79 billion over the last five years, rising from $22.15 billion in April 2011 $30.94 billion in January 2016. During the same period, JC Penney (NYSE: JCP); a department-store operator that caters to middle class customers, saw its revenues drop by $5.14 billion. Penney’s reported revenues of $17.77 billion in April 2011 and $12.63 billion in January 2016.

Nor was it just revenue; TJX reported a profit margin of 7.44% in January 2016, JC Penney reported a negative profit margin of -1.78% on the same day. To make matters worse, JC Penney also reported a loss of -$513 million in January 2016; TJX reported a net income of $2.278 billion at the same time.

How Income Inequality Helps TJX

These financial numbers correlate with economic data from the Pew Income Study; Pew’s numbers crunchers determined that median middle class incomes in 2014 were 4% less than they were in 2000. To make matters worse, Pew found that the median wealth of middle class households fell by 28% between 2001 and 2013. At the same time the percentage of Americans in the lowest income level grew to 20% in 2015.

Pew’s numbers show us why TJX has been doing so well and why Penney’s is struggling. Average Americans simply have less money to spend, yet they still need clothing to wear. That puts discounters like TJX and its competitors such as Ross Stores (NASDAQ: ROST) because they can offer the clothes Americans want at low prices.

Ross saw its revenues grow by $3.934 billion between April 2011 and January 2016. Ross reported revenues of $8.006 billion in April 2011 and $11.94 billion in January 2016. Ross also reported a net income of $1.021 billion and a profit margin of 8.13% in January 2016.

Mr. Market Has Noticed

The Pollyannas in the media and our political leadership may have not noticed this trend, but Mr. Market has definitely paid attention. On April 14, 2016, Ross was trading at $56.49 a share, while TJX was trading at $76.23 a share. Meanwhile, JC Penney was trading at $9.75 a share.

Investors who paid attention made some money; owners of TJX shares received a 53% return on equity, and a dividend of 26¢ a share. Those who bought Ross stock were rewarded with a 43.01% return on equity, and a dividend of 13.55¢. Penney shareholders lost 31.36% of their investment and received no dividend.

It looks as if betting against the return of prosperity and the recovery of the American middle class, is an effective strategy for investors. Obviously this strategy is saddening and morally troubling, but intelligent investors need to take advantage of the economic realities of the times in which they live.

Something to remember is that neither the executives at TJX or Ross, nor the investors are responsible for this situation. The economic reality is the result of technological, political, social and other developments far beyond their control.

Brick and Mortar Retail has a Future

The revenue growth at TJX Maxx and Ross tells us something else: brick and mortar retail has a future. It is still possible to make a lot of money selling certain kinds of merchandise, such as clothing through physical stores – if you find the right niche.

The growing revenues at discount department stores proves that there is a large class of American shoppers that still do most of their clothing purchases at brick and mortar stores. It could be that working and lower-middle class Americans have not yet jumped on the online shopping bandwagon.

That indicates we could be moving towards a serious disconnect in American retail; with upper-income Americans shopping at Amazon (NASDAQ: AMZN), while the increasingly cash-strapped working class turns to brick and mortar discounters. This could be a huge opportunity for investors that can identify which retailers are best-positioned to take advantage of this trend.

Both TJX and Ross seem well situated to continue cashing on growing income inequality. Smart observers should take note of the situation and invest accordingly.