3 retailers to compound your wealth this cycle

Key Points

• Considering these valuation indicators, Japan's 'lost decade' could be close to what the S&P 500 will experience.
• Picking stocks unaffected by the business cycle becomes critical in this period, as well as products that don't go out of style.
• Adding high rates of return on capital will allow you to line your portfolio up with an opportunity to compound your wealth.

Today's market is the epitome of opportunity for those who know where to look. Considering that most market analysts suggest the stock market is overvalued today, by measures such as the Buffett indicator (Which is a ratio of the stock market to GDP), and even fear to greed gauge indexes. Here's what that means.

Every time these markers swing one way, signaling a potentially overvalued stock market, the next cycle brings about lackluster returns in the S&P 500, so your money is at risk of taking a bit of loss or - in the best case - staying flat in the next cycle. Those who know this understand that finding above-average returns is critical to building wealth.

By metrics and reasons that will become obvious in just a bit, stocks in the retail sector like ULTA Beauty NASDAQ: ULTA, AutoZone NYSE: AZO, and even Tractor Supply NASDAQ: TSCO all play on the secular trends of basic consumer needs, and all count with more than able management to keep delivering value to shareholders.

What to look for 

Over the past twelve months, the Consumer Discretionary Select Sector SPDR Fund NYSEARCA: XLY has outperformed the broader S&P 500 index by as much as 5.6%, considering the strength of the U.S. consumer during this period. This price action could signal continued strength in the sector, but not all stocks are made equal.

Some stocks will be taking a hit in the coming months, as some commercial banks like Bank of America NYSE: BAC, Citigroup NYSE: C, and Wells Fargo NYSE: WFC have reported - in their latest quarterly results - rising net charge-offs in their consumer loan departments, namely credit cards.

So look, beginning with this knowledge, you may want to stay away from the highly cyclical stocks in the consumer space, and then consider those products and services that don't go out of style, regardless of where the business cycle sits currently. 

You will now appreciate the selection of these stocks made today. ULTA's products will be a resilient place to seek growth and safety, considering beauty and skin care products don't necessarily fluctuate in demand with the economy. Likewise, farmers need to farm, so Tractor Supply will still be in business as long as people need to eat.

On top of all this, AutoZone is not in Europe, where people can just walk everywhere. You need to have a car to get anything done in today's economy, which is why this stock will likely survive any business cycle contraction, assuming people keep owning - and taking care of - their cars.

Numbers check 

A story without proper numbers is just a fairytale, and you are not here to invest in a pretty picture without understanding how these companies will provide an adequate rate of return. So today, you will look at the same metrics that value investors worldwide consider when picking their winners.

Beginning with ROIC (return on invested capital), you want to make sure this metric is as high as responsibly possible, which will speak to management's ability to protect and allocate the business' capital in a way that rewards shareholders.

Here's the sweetener: historically, annual stock price performances tend to mirror the long-term average ROIC rate. In this sense, owning stocks with high historical ROICs is the surefire way to compound your wealth in a multi-year holding period. 

ULTA's financials will show you an average ROIC of 25.0% in the past five years, which could allow you to roughly double your capital every three years; not bad! Unsurprisingly, analysts at UBS NYSE: UBS expect the stock to go up to $575.0 as a price target, which is 20.0% higher than today!

AutoZone brings you an average ROIC of over 30.0%! You should have seen this coming, considering the space in which this company operates. Morgan Stanley NYSE: MS slapped on a price target of $2,900.0 a share in this stock, saying it could go up by 13.0%, a fraction of reality considering its ROIC.

Last but not least, an average ROIC of 14.0% in Tractor Supply can top off this potential value-compounding portfolio. While analysts are seemingly bearish in some agricultural names, this stock could soon begin to shine once that sentiment inevitably pivots.

With protection found in the knowledge that these products will not go out of favor - or at least should not - during the changing economic cycles, overlaid with good management generating high rates of returns on capital are the two main ingredients value investors look for when deciding where to deploy their capital.