They say timing is everything, particularly when it comes to
stockinvestment . I don't disagree. That's why I recommended
caution with most of the major super-discount retail stocks
back in April
-- it just wasn't the right time to take on a new position in any
of those stocks.
A lot can change in eight months though.
And it has at least for one of these discount retailers. Thanks
to some more encouraging clarity on theearnings front combined with
a big release of the technical tension its chart had brewed up,
this stock is now a compelling buy.
Insanelyovervalued in a recent past
It's no real secret that dollar stores such as
Family Dollar (
FDO
)
,
Dollar Tree (Nasdaq: DLTR)
, and
Dollar General (
DG
)
have been on a roll since the GreatRecession . Consumers are still
feeling pinched and in need of real value for their dollars.
Retailers that can give shoppers the most bang for their buck stand
to win plenty of new business, and these three stores have sure
done so.
This isn't just a theoretical benefit either. As I reported in
April, since 2008, Family Dollar has managed to grow itsbottom line
at an average annual pace of 23%. Dollar Tree's income has grown an
average of 31% annually since 2008. Dollar General's bottom line
growth has reached triple-digit proportions during the past three
years, and even though it started to slow lastfiscal year , that's
largely because it was running out of viable places to plant its
flag.
Take a look at the chart below...
That growth is nothing less than phenomenal and investors were
right to be impressed. Investors weren't right, however, to pay an
excessive price for that growth -- even heavyweight investors
likeWarren Buffett , who took on a $48 million stake in Dollar
General shortly before my April article.
At that time, Dollar Treeshares were sitting on top of a
three-year rally that sent the stock soaring 300%. Family Dollar
had rallied nearly 200% during the prior four years, while Dollar
General shares had doubled in value since late 2009.
The size of the rallies themselves weren't the problem with
these stocks, however. The red flag was simply that these rallies
had been a lot stronger than earnings growth, leaving all three
stocks at price-to-earnings (P/E ) ratios high enough to make even
some technology and growth investors a little nervous. Dollar
General was trading at 19.5 times trailing earnings in April, while
Family Dollar and Dollar Tree were trading at 18.6 and 23.5
respectively.
Yes, many stocks have survived worse overvaluations, but those
stocks weren't from the world of discount retailing either. That's
why I specifically made the point that "the right time and price
for an entry is probably going to require about a 25%correction
from peak levels."
And guess what finally happened since then...
A nice entry point to claim your stake
In the interest of fairness, though my suggestion was on target, my
timing was off -- the group's peak and subsequent pullback didn't
start until June. But, it did happen -- in spades. Dollar General
fell 18% between its high and low during the middle of the year,
while Family Dollar shares gave up a little more than 17% of their
value between June and September. These moves certainly burned off
a great deal of any overbought pressure, but they haven't burned
enough off to merit an entry into either stock yet.
Dollar Tree, however, has completely cleared its decks with a
whopping 33% pullback that didn't end until earlier this month.
With all the would-be sellers likely shaken out already, this
stock's chart has an enormous amount of room to continue this
rally.
That being said, this isn't a purely-technical investment idea.
Although Dollar Tree shares have more room than Family Dollar or
Dollar General have before resistance kicks in, the stock is
supported by a solid fundamental argument, too. It's the cheapest
of the three stocks in question on a trailing P/E basis, and after
15 earnings beats in a row, that projected P/E ratio of 14.6 may
well underestimate the company.
Risks to consider:
Ironically, the one thing that could trip up any of these three
stocks is a firm rebound in theeconomy . If spending preferences
return to higher-priced goods, then these retailers won't
exactlyoffer what the average consumer wants these days. Also,bear
in mind that none of these stockswill be able to grow in the future
as rapidly as they have during the past three years.
Action to Take -->
While the deep-discount space continues to be rewarding for all of
its key companies, make no mistake -- Dollar Tree is the stock to
step into if you're looking to stake a claim now. A 20% gain from
current prices could be realized in the very foreseeable future.
But, given 2011's romp, a 40% reward could be in the works for
investors willing to stick with it for a full year or so.