In this article to assess the value present in dollar stores, I am using a formula of finding value that I present in my book. It is the first step of three in finding an investment, but will tell you if a stock is fairly valued, over-valued, or undervalued relative to the market.
What we are looking at is current value, not value relative to future earnings. In this case, we compare the growth of industry-leaders to the broader market.
Multpl.com provides up-to-date value information for the broader market, and will be used to find the averages. According to Multpl.com, the S&P 500 saw Q1 sales growth of 3.76%, trades at 1.51 times sales, and has a current P/E ratio of 19.1.
These three metrics are the ones that will be used, as each is universally important to valuing the market and a company both psychologically and fundamentally. On a side note, earnings growth can be used in place of sales growth, but when assessing economic growth I believe that sales is a better indication of overall improvements.
Looking at Dollar Stores
| Dollar General Corp.(NYSE:DG) | Family Dollar Stores, Inc. (NYSE:FDO) | Dollar Tree, Inc. (NASDAQ:DLTR) | Fred’s, Inc. (NASDAQ:FRED) | |
|---|---|---|---|---|
| Q1 Sales Growth | 0.50% | 17% | 8.3% | 0.2% |
| Price/Sales Ratio | 1.10 | 0.71 | 1.46 | 0.30 |
| P/E Ratio | 18.79 | 17.02 | 17.7 | 18.5 |
When you compare each of these four companies to the S&P 500, all with the exception of Fred’s and Dollar General posted better Q1 sales growth, and all of the four companies are cheaper in price/sales and P/E ratio compared to the S&P 500. Therefore, we can conclude that there is some level of value present within the industry as a whole.
As I look at these four companies as individuals, the only one that is immediately eliminated as the worst value is Dollar General Corp. (NYSE:DG). The company has the worst growth of the four and is the most expensive on a price/earnings basis.
Fred’s, Inc. (NASDAQ:FRED) is a very cheap stock – trading at five times below the S&P 500 average compared to sales. However, its lack of growth is a bit disheartening to me.
This leaves Family Dollar Stores, Inc. (NYSE:FDO) and Dollar Tree, Inc. (NASDAQ:DLTR) as the remaining options. Both have very strong growth that far exceeds the S&P 500 growth and are cheaper on a sales and earnings basis. At first glance, Family Dollar looks to be the clear winner between the two – as it had faster growth and is also cheaper on a price/sales basis.
One More Unnamed Metric In Retail
The exercise above allows us to see a general level of value relative to the S&P 500, and is a good starting point for retail investors. However, each industry has a niche, or a metric that is more important than in other industries. In retail, it is comparable store sales.
A retail company can easily grow its year-over-year sales by adding new stores. However, comparable store sales growth lets us know that new customers are coming in the doors of existing stores. Furthermore, as comparable store sales grow — margins also increase – and this can be more impactful to the performance of a retail stock over any other metric.
| Company | 2013 Expected Comparable Sales Growth |
|---|---|
| Dollar General | 3% |
| Family Dollar | 3-4% |
| Dollar Tree | 2% |
| Fred’s | (1%) |
Looking at the chart above, my opinion remains intact. Fred’s, Inc. (NASDAQ:FRED) is seeing its traffic decline in its store, which should weigh on the fundamentals long-term.
Dollar General Corp. (NYSE:DG) does have strong comparable sales guidance, although with the company closing inefficient stores, total sales growth is minimal.
Therefore, I believe Family Dollar Stores, Inc. (NYSE:FDO) and Dollar Tree, Inc. (NASDAQ:DLTR) are without question, the strongest in the space.
Final Thoughts
After concluding that Dollar Tree, Inc. (NASDAQ:DLTR) and Family Dollar Stores, Inc. (NYSE:FDO) are the best within an undervalued space, I believe Family Dollar is the clear winner of having the best value.
Not only is Family Dollar Stores, Inc. (NYSE:FDO) growing the fastest, cheaper compared to sales, and has greater same store sales growth, but is also the only of the dollar stores that pays a dividend yield. The company’s 1.6% forward yield is nothing to brag about, however it is good enough to give the company a greater advantage over its peers.
On a side note, I do think Dollar Tree, Inc. (NASDAQ:DLTR) has a long-term sustainable business model (everything’s a $1) and that it will also outperform the broader market over the long-term. The company has the highest operating margins of any dollar store.
The fact that Dollar Tree’s operating margins are almost twice as high as Family Dollar, and it offers all of its products for just $1 is simply incredible. The company has a great business model, a great supply chain, and industry-best vendors. Thus, both are good, but Family Dollar is still the best!
Brian Nichols is long DLTR. The Motley Fool has no position in any of the stocks mentioned.
The article Which Dollar Stores are a Buy? originally appeared on Fool.com.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
