Eden Capital's Newar: "We're investing in the reinvigoration of the American consumer."

There's a season for everything, and 2008 was no time to be in retail stocks. Shares in Abercrombie & Fitch, Saks and Guess were all down 70% or more as the credit crisis morphed into a deep recession. The selling was so indiscriminate that Tiffany & Co. reported higher sales and earnings that year and still lost 57% of its value.

Retail stocks came roaring back in 2009, but with investors now fretting about market volatility and Europe's credit troubles, many are still below prerecession highs. The retail sector is trading at 17 times 12-month trailing earnings. That's about where the multiple was before the crash, but earnings have been depressed by two years of deep recession.

That spells opportunity to Adam Newar of Eden Capital. The Houston money manager, with about $100 million under management in short and long positions, sums up that opportunity in two words: operating leverage. By that he means the potential for retailers' earnings to rise much faster than revenues as they cover fixed costs and an increasing percentage of sales flows to the bottom line.

"We're investing in the reinvigoration of the American consumer," says Newar, 48.

The Harvard Business School graduate, whose clients include institutions and wealthy individuals, invests in a broad array of sectors but also overweights areas he believes are promising. Ten months ago banks were his favorite holding. Now it's retail. Eden owns Saks ( SKS - news - people ), Abercrombie & Fitch ( ANF - news - people ), Chico's fas and Guess.

With their big fixed costs in salaries and lease expenses, retailers are the classic example of operating leverage. Saks, for example, pays about $102 million a year to lease its 78 Saks Fifth Avenue and Off 5th stores. Selling, general and administrative costs chewed up about 25% of its $2.6 billion fiscal 2009 revenue and interest costs another $50 million.

Saks' sales were about $350 per square foot last year, compared with $500 at Neiman Marcus and $1,000 at high-end jeans purveyor Guess. If Saks can boost sales only 11% this year and keep SG&A expenses from rising as much, Newar figures earnings will come in double the current consensus forecast of 20 cents a share for the year through next January. Earnings before interest, depreciation and taxes--an important measure of the company's ability to generate cash--will more than double from the last fiscal year to $240 million in the year through January 2012.

Other retailers are already piling up the cash: Abercrombie had $680 million, or $6.86 a share, as of Jan. 30. Recent stock price: $35.

Newar admits that retailers' stocks have a well-deserved reputation for volatility, collapsing on management mistakes and changes in consumer tastes. Such volatility, of course, is your enemy only if you're on the wrong side of it.

"You've got to decide if the concept [behind a retail strategy] is viable and sustainable," he says. That's an exercise requiring store visits and a good sense of where the market is headed, as well as financial analysis. Blockbuster ( BBI - news - people ), for example, "had a terrific track record over a decade," but investors who didn't notice the competition from DVD subscription vendor Netflix ( NFLX - news - people ) got crushed.

For a peek over the retail horizon, Newar keeps a close eye on same-store sales comparisons, which measure revenues at outlets open a year or more. He cautions that retailers can manipulate the figure by, say, counting sales at renovated stores under the same-store rubric. Wipe away such games and the number gives a telling look at whether a concept is working. A same-store sales decline is often the first sign that rivals are encroaching, even when store openings keep total revenues rising.

Newar says he made money in the late 1990s shorting bagel shops, like Einstein Brothers, after seeing sales fall at the store level even as the parent appeared to be growing via franchise fees. In contrast, Eden doubled its money on its three-year investment in Tractor Supply ( TSCO - news - people ), an operator of farm and ranch supply stores; its shares jumped tenfold in the five years through 2006 as it expanded into rural areas where it faced little competition.

"You're looking for an inflection point from negative to positive," Newar says.

As consumers emerge from their bunkers, he figures big clothing and household retailers, like those listed above, will experience the positive side of leverage.

#### Bargain Stores

Money man Adam Newar believes earnings of retailers like those below will rise fast during an economic recovery.
|  | 2011 Estimate
Company | Recent Price | Enterprise Ratio* | P/E
Abercrombie & Fitch | $34.65 | 5.2 | 14
Chico's FAS | 11.95 | 5.5 | 13
Guess | 35.71 | 6.0 | 11
Tiffany | 44.69 | 8.3 | 14
Saks | 8.79 | 11.4 | 21
Prices as of June 1. *Market value plus debt minus cash divided by earnings before interest, income taxes, depreciation and amortization. Sources: Eden Capital; Interactive Data via FactSet Research Systems.