(FORTUNE Magazine) – Judy Lugo is one-third of a fairly typical middle-class American family. She drives a Toyota Camry and lives in a two-story shingled home in Highland Lakes, N.J., with husband Ray, whom she met while teaching a class on installing tech systems, and their 6-month-old son, Lorenzo. On weekends she and Ray like to play Scattergories with friends. Oh, and she delights in bargain hunting. A velvet evening gown marked down to $20, she beams, was her best deal yet.

All of which makes her a target: Sears is angling for her business; J.C. Penney is desperate for it. Target and Kohl's are confident they can keep her coming back, while Kmart is hoping she will just stop by. In an effort to coax open Judy's wallet, these five retailers--members of the moderately priced pantyhose-to-picture-frame set where middle America shops--are realigning their merchandise, crowding the airways with ads, even mimicking each other to try to shift some of the Lugo's business their way.

They have to: The competition, says Sears CEO Alan Lacy, "has intensified enormously." On one front is the ever-encroaching threat of powerhouse Wal-Mart; on the second is the sniper-like accuracy of category killers such as Best Buy and Bed Bath & Beyond. The rivals "continue to divide the consumer's dollar into smaller and smaller pieces," says John Champion, managing director, North America, at retail consulting firm Kurt Salmon Associates. Which means that while Sears, J.C. Penney, Target, Kohl's, and Kmart all may want the Lugo's business, they can't all have it.

That's the bad news for these Main Street merchants. The good news, if you can call it that, is that discount and value outfits have been among the few winners in retail lately. In October alone, while Gap same-store sales fell 17% and May Department Stores' dropped 6%, Kohl's same-store sales rose 13.5% and those at Target stores were up more than 4%.

So what does all of this mean for retail investors? To handicap the players, we talked to company executives and analysts. But we didn't stop there. On the theory that you can only know a store by shopping there, FORTUNE spent a November Saturday in northern New Jersey visiting each of the five stores with the Lugos. What did they buy? Where did they skimp? Most important, what might it mean for your portfolio?

It's 10:45 A.M., and the Lugo family is trundling through the Sears in the Willowbrook Mall. Judy, petite and smartly dressed, is pushing Lorenzo in a blue stroller, while Ray, a wiry, mustachioed Yankee fan with a cell phone clipped to his belt, follows behind. As regular Sears shoppers (Judy estimates she's bought 95% of Lorenzo's gear here), they plan to browse, and perhaps to buy. Passing through Sears' brightly colored Tool Territory section, Ray eyes a cherry-red $2,299.99 Craftsman riding mower almost longingly, but keeps walking. "I'm trying to refrain from buying any high-end items right now," he later explains. Still, when they do make a big-ticket purchase, the Lugos trust Sears. "We pretty much get all of our appliances here," says Ray. Judy isn't tempted, however, as they pass through the women's section. "I can walk through Macy's, and tons of things will just jump out at me, like 'please buy me!' " explains Judy. "But it just doesn't happen at Sears."

The Lugos' take on Sears makes sense to CEO Lacy, who has been on the job just over a year. The company tried to promote the "Softer side of Sears," but has lately refocused on such wares as tools, snowblowers, and refrigerators. Speaking to analysts recently, Lacy noted that while Sears was a department store in the past, it "doesn't want to do that anymore." So what does Lacy have in mind? He wants to continue to roll out freestanding hardware stores and The Great Indoors home-furnishings stores, while fine-tuning merchandise in existing mall anchors. The idea is to ditch things customers aren't buying--thus his decision this past summer to stop selling cosmetics.

Editing the merchandise is just one prong of Lacy's plan. In late October he announced the company would slash 5,000 jobs (22% of its salaried work force) and cut $600 million in costs by 2004. He plans to eliminate dozens of private apparel labels and instead focus on one (to be determined) uber-brand. Gradually, the stores will also become more self-service, with shopping carts, better signs, and checkout clusters. Says Lacy: "Our customer is not willing to pay for a department-store level of service, nor do they expect that."

Will it work? This is, putting it diplomatically, not Sears' first turnaround attempt. Many of Lacy's ideas won't hit stores until 2002, and in the meantime sales continue to slump, falling 4.4% in October from a year ago. Investors are worried about the company's ability to fix its clothing business and manage its extensive credit card operation, from which the company derives most of its profits, in a rough economy. Their worries have depressed the stock price, which, at $44, is currently selling at 11 times 2001 earnings estimates. Goldman Sachs analyst Adrianne Shapira thinks the stock is undervalued, but other retail watchers are less sanguine.

So is Ray. Back in the men's department he checks out a $19.99 fleece sweatshirt by an in-house brand called Trader Bay, but decides he'd rather go with a name brand like Champion. Even with the day's promotion (10% off everything in the store), the model he likes still costs more than $24. "Maybe you should wait and look at Penney's," suggests Judy. "They're having a one-day sale."

A sale, indeed. The promoters at J.C. Penney aren't trifling with the subtleties of language. Posters plastered around the store in the Wayne Town Center mall proclaim this the BIGGEST SALE OF THEM ALL. By 11:30, the store is packed with shoppers, the aisles clogged with merchandise tables. "It's hard to maneuver," says Ray, as he wheels Lorenzo's stroller around a table of Timex watches. "When Penney's has a sale, to me, it's a sale," says Judy, eyeing a table of nubby sweaters ($24.99 for the first, 88 cents for the second). "It's guaranteed I'm going to leave with a shopping bag," she adds.

She's not the only one. Same-store sales at the department stores rose 5.1% in the third quarter, and Eckerd, the drugstore chain that Penney's bought in 1997, also posted strong gains. In all, it's a marked improvement over the company's dismal late-'90s performance, when shoppers scoffed at Penney's dowdy fashions and investors were turned off by its equally out-of-style stock price. The slump was so pronounced that Penney's, with more department stores than any other company, saw its share of general apparel and merchandise sales (the broad category that includes furniture, apparel, and appliances) fall from 3.5% in 1990 to 2.4% in 1999.

Now the company is making a bid for relevance under the guidance of Allen Questrom, the polished, silver-haired retailing veteran who brought Federated out of bankruptcy. Questrom joined J.C. Penney a year and a half ago and, as the first outside CEO in the company's century-long history, had his work cut out for him. For starters, he oversaw the efforts under way to centralize the shockingly inefficient buying operation, which called on each of the 1,100 store managers to buy merchandise for their individual stores. Then he had to fix the merchandise itself: Clothing has been spruced up, and the stores are starting to group items by product type rather than by brand, making it easier for customers to find what they want. "They're adopting a Kohl's approach," says one analyst. "Less is more; give the consumer a good, better, best choice; make sure you have those three choices in every color, every size." Already the company is getting coveted nods from fashionistas. In November's InStyle magazine, J.C. Penney's $89 Mixit leather skirt is displayed appealingly alongside gear from the likes of A/X Armani Exchange and Stuart Weitzman.

But a pretty picture in a glossy magazine won't fix all that ails the company. There is still, for one thing, the problem of the stores. Penney's mall-based model means it's tethered by long-term leases to shopping centers, some of which have long ceased to be in desirable locations. Inside, too, the stores need attention. While the J.C. Penney outpost a mile from the company's Plano, Texas, headquarters is brightly lit, clean, and well-stocked, in the Wayne store a mishmash of clothes and overflowing displays create an aura of chaos. In Questrom's opinion, the average store still earns just a C grade.

Nonetheless, Wall Street has been impressed with what the new CEO has done. Penney's is the best-performing stock on the S&P 500 this year, though it has fallen from its recent peak of $30 to around $23. "If you just look at what they're earning this year and next year, it's not a cheap stock," admits Bill Nygren, respected value manager of the Oakmark fund, who began buying the stock a year ago. But Nygren bets that by 2005 the company could earn $5 a share, quite a distance from the 35 cents a share it's expected to earn this year. "They've still got a long way to go," says Nygren, "but finally the game plan is correct."

Meanwhile Ray, who is pawing through a rack of Champion sweatshirts, is about to do his part to keep sales growing apace: Penney's has the same sweatshirt as Sears, but at a sale price of only $17.99. Who cares if he has to navigate through odd collections of tool kits and then endure two women bickering loudly about who was first in the long line to pay? He has scored a deal.

Just half a mile down Route 46, the Lugos slide their white Camry into a parking spot, and with the clock nearing 12:30, head toward the spanking-new facade of a Target Greatland. "I can come in here and just find tons of stuff I think I need," Judy says, breaking into a wide grin. That kind of enthusiasm fueled a remarkable run through the 1990s: Target started the decade with a 1.7% share of general merchandise sales; now it has 3.4%. Its stock rose steadily through the latter part of the '90s, but has been bouncing around in the $30 to $40 range for almost two years.

The problem? "It's the department-store drag," scoffs one money manager who has shunned the stock because of Target's other, less successful, holdings. In October, for example, while Target units saw same-store sales rise 4.1%, sales at its Mervyn's division were down 1%, and those at Marshall Field's swooned 10.1%, depressing the company's overall increase to 2%.

In its core business, however, which delivers 75% of revenues, there is no question that Target has cultivated an envied edge with people like the Lugos. This success is due in no small part to in-house partnerships with designers-of-the-moment (Mossimo, Michael Graves) that deliver distinctive merchandise for shoppers, not to mention high margins for Target. The next high-profile launch will be a Gen Y brand called Phys.Sci., due to hit stores next year. Target has developed, says Jeff Klinefelter, an analyst with U.S. Bancorp Piper Jaffray, "a truly creative next-generation department-store concept" that gets it out of a commodity business (a can opener is a can opener) into a high-margin brand business (a Michael Graves can opener is worth paying a bit more for). Even Ray isn't immune: Wandering into a well-lit selection of teakettles, he gravitates toward a sleek Graves model. "See, I like that! I want that!" exclaims Judy. "If he weren't here I'd buy that," she adds conspiratorially.

Target (like Kmart) is also imitating Wal-Mart by expanding the SuperTarget concept, which combines a regular store with a full-service grocery, selling deli foods, produce, baked goods, and the like. There are already 62 SuperTargets around the country, with more than 200 planned in the next decade. The grocery business drives more traffic to the stores, and the company has said that overall store sales are 60% to 80% higher than at regular Targets because customers shop twice as often.

With Target's stock off its midsummer highs of near $40 (it's now trading at 23 times 2001 earnings) some value managers are looking to snap up shares. "As an investment, it's very compelling right now," opines Klinefelter, who predicts that as consumers become more tightfisted Target will benefit. "Crate & Barrel shoppers shop at Target, not Wal-Mart," he says. "They're taking share away from higher demographics."

The Lugos, who suddenly remembered somewhere along the kitchenware aisle that they need a trivet, find not one but three they absolutely must have, and snap them up for $15.87.

After lunch at Bennigan's, it's off to Kmart, which is (inconveniently) a full six miles away from the other stores. Plunked down across the parking lot from the Wayne Hills Mall, the tired facade of Big Kmart sits adjacent to a defunct Pathmark supermarket. After the stark orderliness of Target, the scene is gloomy. "It just looks so cluttered and messy, and that gives you the impression that the quality isn't as good," says Judy. Indeed, discounted Halloween costumes spill onto the floor near the entrance, and ceiling tiles are stained brown with water spots. "I wouldn't come here to browse like I would Target," says Judy.

That's an inauspicious verdict on the supposed turnaround that Kmart has been trying to pull off under Charles Conaway, the youthful-looking CEO who took the reins in May of 2000. He has cut costs (the company will save $500 million this year), jobs (20% of the work force), and stores (closing 69 unprofitable ones over the past year). Like Wal-Mart and Target, Kmart is also counting on groceries to fuel future growth: Under the SuperCenter banner, Kmart expects to open 124 combination stores by year-end, and has identified some 1,300 more that can be converted.

Still, in October, same-store sales were down 4.4%, although last year's results were artificially high because of a one-time liquidation sale. Lehman Brothers analyst Jeffrey Feiner terms sales "erratic." The stock, which rose from $6 a year ago to around $13 in August, is now back at $7. For a distant third-place player in a fiercely competitive industry, Kmart stock is still no bargain at 29 times earnings.

There is some good news: The company is extending its successful partnership with Martha Stewart through 2008 (her kitchen twine looks fetching, even at $4.99) and recently signed exclusive apparel deals with Disney and Joe Boxer. Kmart also hired Mariana Keros from Target Corp. a year ago to head a new group called Trend and Product Development. Her job is to translate trends in fashion and decorating into new product ideas. With plans for a series of heavily promoted "must-have items" for the spring of 2002, she says the stores will have "more of an attitude than today."

They could hardly have less. Judy points toward a baggy maroon $34.99 women's jumpsuit: "I mean, can you see me wearing that?" The one thing that does catch their eye is ... toilet paper. "I've never seen this many rolls for $3.14," says Ray in a slightly awed tone, picking up a 12-pack. They splurge on a roll of paper towels too. Grand total? $4.06.

Just past 4 P.M. the Lugos pull up at the last stop, Kohl's. The vast majority of Kohl's stores are in strip centers, and this Kohl's is flanked by KB Toys, Mr. Cleaners, and an outfit called the Spa Lady. Even after a full day of shopping, Judy still manages to get excited about the Kohl's shopping carts--undersized sleek black numbers that come in various models to accommodate babies, toddlers, or just lots of merchandise.

Shopping carts are one of many seemingly simple innovations Kohl's has brought to the sector. The chain, based in Menomonee Falls, Wis., has grown to be a stock market darling, turning in a decade of 15%-plus revenue growth. Rather than mimic discounters or department stores caught in a cycle of slash-and-burn promotions, Kohl's aims to offer consistent value on name-brand items. "I haven't seen tremendous sales here," says Judy. But then again, shoppers like the Lugos don't hold out for the biggest sale ever to buy.

Architecture is central to Kohl's success. The stores are laid out on one level and take up less than half the space of a typical J.C. Penney or Sears. They're designed around an easy-to-navigate racetrack, with clearly delineated departments for men, women, kids, and home. One thing shoppers won't find is hordes of customer-service reps: To keep costs down, Kohl's is self-service, with a supermarket-style checkout at the front of the store. The combination has struck a chord--Kohl's has been performing steadily, and in October it racked up 13.5% same-store gains. With an abundance of strip centers to choose from (especially in the South and Northeast), Kohl's could grow from 382 stores today to almost 700 over the next five years, according to Bear Stearns.

But there's a hitch: "See, I have a real problem paying $80 for this," says Judy, practically snorting as she picks up the sleeve of a checked blazer. "If it were in Nordstrom maybe, but for some reason in a store like this I could never." And blazers aren't the only thing about Kohl's that is pricey: The stock itself trades at 46 times this year's earnings. "Kohl's stock price right now is based on taking share easily from competitors over the past several years," says Klinefelter. Should the competition heat up, expect Kohl's stock price to take a hit too.

Midway around the racetrack, a well-placed display of sleek $24.99 Black & Decker SmartBrew coffeemakers catches Judy's eye. Turns out she had been thinking of buying a new one. But off the aisle are more models to choose from. "Watch," Judy says under her breath, looking toward Ray in the next row. "He'll want to get a cheaper one." She's right. They end up picking a $19.99 model. Just paces away, Judy spots a baby-blue jumpsuit for Lorenzo, which is a steal at $8.99. As she searches for baby socks, Ray sets out to apply for a Kohl's card (he already has cards from Sears and Penney's). With the first-time purchase discount, the Kohl's total rings up to $36.82.

Having spent six hours and $74.74, the Lugos ponder which company they'd buy stock in. "Sears," says Ray instinctively. "I'm a customer for life." Judy, on the other hand, is stuck on Target. "I'm your average shopper: I'm a mom now. I'm a career woman. I'm just drawn to Target," she says. "There's just something about that place that makes me want to spend money." And that, of course, is what any investor wants to hear.

FEEDBACK: lclifford@fortunemail.com