It was probably one of the last industries anybody was expecting great things from as we headed into and out of the 2008 recession. 

But numbers don’t lie. 

#-ad_banner-#This industry has proven to be practically bulletproof in terms of earnings growth, regardless of the economic environment. So, as is so often the case, investors jumped onto a clear trend by investing in shares of the highest profile names in the industry. 

In that industry, auto-parts retail, that’s a toss-up between AutoZone (NYSE: AZO) and O’Reilly (Nasdaq: ORLY). At a market cap of$14.5 billion and $12.8 billion respectively, the two collectively dwarf the rest of the industry.

But I’ve found a better stock.

To be fair, it’s not as if the duo didn’t deserve the respect they were getting. AutoZone has increased annual as well as year-over-year quarterly earnings every year since 2006, sailing through the recession as if it never happened. Per-share income has grown from $7.50 in 2006 to $19.47 in 2011. O’Reilly did see a modest degree of turbulence in late 2008, but never actually booked a loss even when things were at their worst. And since 2008, annual per-share profits have rallied from $1.53 to $4.14 recently. No wonder the market’s fallen in love with them since late 2008. 

But this love has caused a problem.

The good news is O’Reilly’s bottom line has ballooned 171% since 2008, while AutoZone’s has grown by 32%. The bad news: O’Reilly shares have skyrocketed in value by 236% during this time, while AutoZone’s have appreciated by 191%. 

These kinds of unexpected gains are fun, especially for investors who got in the early stages. But this kind of growth isn’t sustainable. Both stocks have reached unusually high valuations, with their price-to-earnings (P/E) ratios at or near decade highs. AutoZone is currently trading 17 times earnings, while O’Reilly is priced at a frothy 24.  They can’t go on at this pace, of course, yet investors continue to pour into these two names, without asking “At what price?”

And therein lies the rub: The underlying earnings growth trend is strong, but at current prices, these two stocks are no longer worth it.

The good news is investors can still tap into the sweeping auto-parts trend. They just need to think small. 

Best of breed
It’s unusual how car parts stores have been essentially unaffected by the recession or the subsequent slow economic recovery. Earnings for auto-parts retailers grew even when auto sales plunged in 2009 (which actually makes sense), yet have continued to grow as car sales have recovered.

Auto-parts retail is simply a strong industry now, and even smaller companies — not just O’Reilly’s and AutoZone — are seeing their revenue rise. But this rising tide hasn’t lifted all the industry’s stocks equally. The smaller names are still quite affordable and should be attractive to investors right now. 

Advance Auto Parts (NYSE: AAP) is one of those smaller names with a lot more to offer newcomers. The $5.0 billion company is only trading at 12.5 times its trailing earnings, even if this value was created by a 20% plunge in shares in mid-May. The sell-off was spurred by the company’s warning that the second-quarter bottom line was in jeopardy, thanks to a “meaningful slowdown” in April’s sales. Sure enough, the company missed the second-quarter estimate. Analysts were looking for a profit of $1.82, but the company only earned $1.79. 

Granted, a miss is a miss. In this case, the miss was only a 1.6% shortfall, and the actual bottom line was 33% better than the last year’s second-quarter earnings of $1.35 per share. And let’s not forget that Advance Auto has also posted five straight years of annual earnings increases, just as impressively as O’Reilly and AutoZone have. 

Investors simply overreacted to Advance Auto’s news. Their excessive response is now a great opportunity to buy. 

Yes, new car sales will eventually rebound to the point where auto-parts stores will be negatively affected, but we’re still years away from this scenario. While new car sales are on the rise, the average age of personally-owned vehicles in the United States is now a record 10.8 years, and rising. All those aging cars mean a whole lot of replacement parts are going to be needed for a long while, which is an ideal situation for companies like Advance Auto Parts. 

Risks to Consider: Ironically, the biggest threat to Advance Auto parts isn’t a recession or tepid economic growth. It’s a booming economy, where consumers choose to purchase a new vehicle rather than repair an old one. 

Action to Take –> AutoZone and O’Reilly are solid companies to be sure, and their size and market share make them stable. Advance Auto Parts, however, is benefiting from the same demand, and offers the same growth potential — just at a much more palatable price. 

Given the forecasted annual earnings growth of 19% for the next three years, Advance Auto Parts shares are poised to perform just as well, and won’t run into valuation problems in the meantime.