Q: You also have a Buy on Saks. Why? A: They have managed extremely well in a difficult environment. The lead times for getting merchandise into the stores are much longer in luxury. They were stuck with an inordinate amount of inventory around the holidays last year. So they just went out, without asking permission from their vendors, and cut prices to move goods. Because they were the first mover, they ended up in a very clean inventory position. And their gross margins this quarter were significantly better than what all of us expected. They have really become extremely disciplined, partly by pulling back on the promotional levers. As I said, I don't think there is a huge amount of pent-up demand. But the consumer wants to treat herself. If she had traded down to a different brand of footwear, she might be thinking, "This really isn't working for me" and wants to invest in one or two pricier pairs of shoes. We are seeing that.

Q: One stock you like is J.C. Penney, right? A: What's most unique about Penney versus its competitors is its exclusive-label and private-label merchandise, which is about 52% of sales. Penney is becoming a real destination. Throughout this recession, when everyone's women's clothing business has imploded, that has been one of their strongest categories. It is run by Liz Sweney, who is a brilliant merchant.

Q: Let's move on to your last pick. A: Home Depot is the largest home-improvement retailer in the world. Frank Blake stepped into the CEO role in 2007, following the departure of Bob Nardelli, and he assembled a very strong team. He had to completely change the corporate culture; they had gotten rid of a number of full-time employees in the stores. He also had to improve the technology. He hired the former chief technology officer at Wal-Mart, Matt Carey, who previously worked at eBay. At the analyst meeting in June, he said it was 1991 for Home Depot, compared with Wal-Mart's technology, and that Home Depot needed new merchandising tools, among other things. He said merchants didn't have the tools they needed to buy effectively; they didn't have any visibility into the stores or supply chain, and they weren't able to effectively control gross margins for their products. New technology will allow them to do this. In another area, they opened their first rapid-deployment distribution center in March of 2007. Prior to that, they had 2,000 stores placing orders with every vendor. Everything, for the most part, was direct-store delivery. Even if you just changed that, the savings would be huge. So they are moving, hopefully by the end of 2010, to having 20 rapid deployment centers, and about 75% of product will go through their own distribution network. There's considerable savings, and it's how you build relationships with vendors. You also improve in-stock levels. The implications are huge, and this is just one project. Also, in this environment, DIY -- do it yourself -- is very big. So they've trained electricians, carpenters and plumbers as salespeople, and given them a badge that says: "Master Trade Specialist." So not only can they serve you and me better in the stores, but they can also educate the rest of the Home Depot work force.

Q: Why is technology an issue? A: Because retailers have been so late to the game. That's the underlying story at Saks [SKS]. They have invested a lot in technology. So has J.C. Penney [JCP], which has spent a lot of time on cycle-time reduction. And there's Home Depot, which is upgrading its technology. That's the common thread in terms of the retailers we have Buys on. Consistent with this theme, Nordstrom [JWN] did a major technology implementation in 2004, and now they have some of the best inventory turns in my coverage universe.

Q: Among the stocks you cover, you have a lot of Hold ratings, including Wal-Mart. Why aren't you sold on that retailer? A: You would have thought these would be Wal-Mart times. Yes, store traffic has been positive. But I don't think they have done as well as a lot of us would have expected. If you look at their second-quarter earnings, their gross margins improved by 1.09 percentage points in the U.S. They aren't giving everything back to the consumer that they could by being more aggressive on discounting.

Q: Are some of the retailing stocks ahead of themselves, given their moves since March? A: Retailers making incremental improvement are the ones, for the most part, whose stocks have moved. We had double-digit negative same-store sales, or comps, for a lot of retailers in late 2008. But Kohl's [KSS] is in positive-comp territory. For a retailer that sells discretionary items, their results have continued to surprise on the upside, and they have completely pulled away from the pack. Some of this has to do with about 50% of their stores being within a mile of a Target store. We go back to this notion of a new normal and the consumer looking for value. Kohl's has done such a great job in terms of delivering value to the customer at the right price that Target has lost share to them on apparel and home goods. And then you have Wal-Mart on the other side, offering the absolute lowest prices on apparel or home goods. But if you want a little bit of fashion or style, you go to Kohl's.

So that's why you have Target as a Sell? We downgraded it in February of '08 on concerns over credit, women's apparel and a lack of a value message versus Wal-Mart. It was a great call for awhile, and the stock is still down from where we downgraded it. But none of those concerns have really changed. While foot traffic turned flat in August, the company continues to disappoint in sales of discretionary items. We believe that their price/value message is less compelling than Kohl's and Wal-Mart.

Q: You also have Costco Wholesale [COST] as a Hold. You would think that in this economy, it would be a solid pick. A: Costco is skewed toward more big-ticket items, including washers and dryers, which have been quite weak. They sell gasoline, and they've also been hit by lower gas prices and foreign exchange. And they've seen a big move into private-label goods, which translates into lower sales, but higher gross margins. They now believe that they can have greater penetration of their own brands. But to me, Costco is an extremely expensive grocery store, trading at about nine times enterprise value to Ebitda [earnings before interest, taxes, depreciation and amortization].