Jeff Stone is courting an entirely new crowd of well-heeled customers these days. All sales should be this easy.

Stone, the president of Tweeter Home Entertainment Group of Canton, Mass., knows all about pitching customers on high-end consumer electronics.

Now Tweeter itself is a darling to institutional investors with huge sums to invest and a powerful appetite for retail stocks. Their interest has helped Tweeter stock to more than triple in five months. Mutual fund managers and other big investors began buying retail stocks in volume two years ago, starting with large, well-known names such as Wal-Mart Stores Inc., Dayton Hudson Corp. and Home Depot Inc.

Since then, demand has seeped down to midsize and smaller niche retailers with a good story to tell. The driving forces haven't changed in two years. Customers are working and willing to spend. Price pressure on manufacturers benefits the retailers.

Now, more institutional investors are looking for companies like retailers that are relatively insulated from uncertain world markets. "Your customer is flush and your cost of goods sold are going through the floor," said Ben Hoch, manager of the John Hancock Growth fund, which invests about 20 percent of its money in retailers. "If you're a typical retail company, it's the best of all worlds." The trend has turned retail stocks into one of the market's stealth top performers.

Measure the 39 industry sector funds operated by Fidelity Investments for performance over 1997 and 1998 and you won't find the winner investing in computers, health care or electronics. Fidelity Select Retailing was the champ, earning 106.6 percent over the two-year period.

Among the big retailers, shares of Wal-Mart and Home Depot are up 230 percent over the past two years. Dayton Hudson and drug chain Walgreen Co. have both tripled in value. Selected smaller retail companies are on a similar trajectory.

Tweeter is the quintessential niche stock with a story to tell. Like other home entertainment retailers, including the much larger Best Buy Inc., Tweeter has an entirely new generation of products to sell thanks to the digital consumer electronics explosion.

Tweeter shares, which went public last summer, have rebounded from an October low of $10.675 to a high of $38.75 several weeks ago.

Not all retailers have been embraced so lovingly by big investors. Despite the powerful tide of institutional money washing over retail stocks, distinct choices are apparent everywhere. Wal-Mart, not Sears. Staples Inc., not Office Depot Inc. Best Buy, not Circuit City Group.

"The story has to be good," said Edward G. Riley, chief investment officer at BankBoston Corp. "The market still differentiates."

But is it reaching a top? Ideal economic conditions and other positives have already been factored into the prices of favored retailers. How much more can there be? The answer isn't obvious.

"I'm not sure you can say things can't get any better than this, therefore it's over," said Fidelity Select Retailing manager Ramin Arani. "We've seen times in the past when companies have grown returns for long periods, longer than people expected."

What is obvious? The stock prices of favored retailers have increased faster than the rest of the market and have become that much more expensive since the rally began.

Shares of the big retailers have undergone "multiple expansion" for the past two years. Home Depot, which sold for about 20 times earnings at the start of 1997, now trades at 45 times profit. Wal-Mart shares have gone through a similar price-earnings inflation over the same period.

Even other midsize retailers have become more expensive in relation to their profits. Staples has expanded its price-earnings multiple about fourfold in the last year.

Higher price multiples reflect increased optimism for individual companies. But they are also a symptom of more investors chasing a limited number of shares, driving up the price of the bet.

Still, investors such as Arani say higher stock-price multiples are sustainable, and can go even higher, as long as companies continue to improve performance.

But just as the money moved into retail, it will head off and find a new home when those favored companies run out of ways to grow.

Pub Date: 3/07/99