Discount chain Family Dollar Stores (NYSE:FDO) has attracted the attention of some high-powered investors.  First, takeover veteran Nelson Peltz, offered $55-$60 a share to buy the company in February, which was rejected.

Then activist hedge fund manager, Bill Ackman, disclosed that he purchased about 4.7% of Family Dollar’s stock. He thinks the company is a target for a buyout.

So it is no surprise that the stock price has been strong over the past year.  The shares are up roughly 38% to $55.53.

Is Ackman right, and there is more room for upside in the stock?  Let’s take a look at the pros and cons:

Pros

Great Concept.  Family Dollar has more than 6,800 locations in 44 states.  Most of the merchandise sells from $1 to $10 and the typical customer is a female head of household, with a lower income tax bracket. 

Also, the typical store footprint is about 7,500 to 9,500 square feet.  Because of this, it means that Family Dollar can provide more convenient locations for customers.

Growth.  In the latest quarter, the company posted comparable sales growth of 5.1%.  Family Dollar is certainly adept at finding the right product mix to maximize the top line as well as generate solid margins.  The company has also been smart to focus more on food and beverage items, which provide for recurring purchases.

Slow Economy.  While unfortunate for most everyone else, this is certainly a big advantage for Family Dollar.  And it looks like the U.S. economy has hit a soft patch, which will mean that more consumers will look for deep discounts.

Cons

Competition.  The discount space is certainly attracting lots of competition.  One of the fiercest rivals is Dollar General (NYSE:DG), which is a highly streamlined operation.  But other companies are entering market, like Wal-Mart (NYSE:

WMT).  The company is exploring the small-format concept.

Margins.  This is always a big issue for discounters, and these have been declining for Family Dollar.  As the company moves into urban markets, the expenses escalate.  Of course, the overall rise in commodities prices has been a problem. 

Renovation.  While Family Dollar is a strong company, its stores look somewhat dated.  As a result, there has been a focus on revamping the locations.  There has also been a rethinking of its marketing strategy.

While such things should improve growth, there are still risks.  In fact, the changes may not necessarily resonate with customers. 

Verdict

Ackman believes that Family Dollar’s stock price could reach $70.  However, this is most likely to be the case only from a buyout.  In light of the company’s strong cash flows and growth opportunities, it would make a good candidate for a private equity firm like KKR (NYSE:KKR) or Blackstone (NYSE:BX).

But even without a buyout, the prospects look good for Family Dollar’s shareholders. The valuation is reasonable, at about 19 times revenue.  There is even a $750 million share repurchase program in place.

In light of the growth opportunities  — and interest from top investors — the pros outweigh the cons for the stock.

Tom Taulli’s latest book is “All About Short Selling” and he has an upcoming book called “All About Commodities.”  You can find him at Twitter account @ttaulli.  He does not own a position in any of the stocks named here.