After last week, investors in the retail sector could be forgiven for looking forward to this week like a trip to the dentist. Indeed, aside from the market meltdown that has continued into this week there were a number of retailers that disappointed – the lone bright spot for me was the speculative offer for Argos owner Home Retail (LSE: HOME) by one of the Big Four supermarkets, J Sainsbury (LSE: SBRY).

This week, however, some retailers have surprised on the upside, especially WM Morrison (LSE: MRW) and Tesco, both of whom have pleased the market.

Let’s be honest, it’s been rare to see our listed supermarkets outpace the FTSE 100 of late, but this seems to have been one of the best places to be invested (at least over the last month that is).

On a roll

As we can see, the best performer (perhaps surprisingly) is embattled WM Morrison. Clearly the market had become too pessimistic about its trading, which can lead to some significant gains if results, when published, surprise on the upside.

Looking through the Christmas trading statement, it seems to me that there were plenty of points that have helped to move the price, including:

  • Internet sales grew by nearly 100%.
  • Net debt was again guided lower to £1.65bn-£1.8bn at year-end.
  • Cash flow improvement programmes were outperforming original expectations and management now expects the benefits, specifically working capital and property proceeds, to be greater than first anticipated.

However, turning to valuation, on a forecast price-to-earnings ratio of over 15, according to data from Stockopedia, the shares don’t scream ‘cheap’. There could well be significant hidden value trapped in the books, an example of which I witnessed when Avesco Group, a company in which I’m a shareholder, announced that it had sold its land and buildings at a site near Wembley (which as at 31 March 2015 had a net book value of £5.3m) for £16m.

Argos it

So, what is it that makes me prefer J Sainsbury?

Well, it’s quite simple really. For me, there are more things to like about J Sainsbury:

  • On a forecast price-to-earnings ratio (12 times earnings) and on a price-to-tangible-book basis (0.82) the shares are much cheaper than WM Morrison.
  • The speculative bid for Home Retail would formally bring together two trusted brands (don’t forget that Argos has already been operating in some larger format Sainsbury stores) and importantly, logistical infrastructure could be rationalised to a degree.
  • Across the combined group there would be, I suspect, a big overlap in property, a portfolio that could be rationalised by management.
  • Even if the deal doesn’t come off, the initiatives that management has put in place to win customers back seems to be on track for now. And investors are being paid a yield of over 4% while they wait – that’s more than the forecast yield of WM Morrison and Tesco combined!

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Dave Sullivan owns shares in Avesco Group. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.