Beware of stocks that have already priced in lofty growth expectations. You can make money if you get in early enough, but you can also lose your shirt on the stock's rapid downslide.
The sector is rife with low switching costs. Companies that establish store loyalty or store dependence are very attractive. Tiffany's is a good example; it faces limited competition in the retail jewelery market.
Make sure to compare inventory and payables turns to determine which retailers are superior operators. Companies that know what their customers want and how to exploit their negotiating power are more likely to make solid bets in the sector.
Keep an eye on those off-balance sheet obligations. Many retailers have little or no debt on the books, but their overall financial health might not be that good.
Look for a buying opportunity when a solid company releases poor monthly or quarterly sales numbers. Many investors overreact to one month's worth of bad same-store sales results, and the reason might just be bad weather or an overly difficult comparison to the prior-year period. Focus on the fundamentals of the business and not the emotion of the stock.
Companies also tend to move in tandem when news comes out about the economy. Look for a chance to pick up shares of a great retailer when the entire sector falls - keep that watch list handy.
Ref: The Five Rules for Successful Stock Investing by Pat Dorsey
Investor's Checklist: A Guided Tour of the Market...