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3 Popular Stocks to Sell Now

Dollar Tree, Dollar General and Family Dollar stores have their fans, but here's why it's time to bail


In a recent macroeconomic paper produced by KKR (NYSE:KKR), the private-equity firm suggests the rebound in consumer spending will be slow for the next three years as shoppers continue a value orientation.

Coincidentally or not, KKR also happens to be the largest shareholder in Dollar General (NYSE:DG), one of the main beneficiaries in a struggling economy. Dollar General, Dollar Tree (NASDAQ:DLTR) and other discount chains continue to produce record revenues and profits.

So let me explain why now is a good time to sell.

When investors think “discount stores,” they usually tend to group them into two categories: dollar stores and Big Box discount stores.

The first category includes companies such as Dollar Tree, Dollar General and Family Dollar (NYSE:FDO).

The second includes Wal-Mart (NYSE:WMT), Costco (NASDAQ:COST) and Target (NYSE:TGT).

The real growth in 2011 came from the first group, which averaged total returns of 33%, compared to 5.7% for the second group of larger, more established businesses. Wal-Mart and its rivals averaged 2.8% growth in earnings in 2011, compared to an average of 17.9% for the dollar stores.

Long-term share prices tend to follow earnings. The spread between price and earnings widened considerably for discount stores this past year. That’s unsustainable over a longer period of time. Reversion to the mean will make sure of it.

On a valuation basis, Morningstar gives all three dollar-store chains one-star ratings. Generally that means the firm believes the stocks are overvalued. The fair value of all three, when added together and then compared with their closing share prices as of March 23, suggests they are trading at a 72% premium to fair value. This compares to a 5% premium for the Big Box stores.

Another way to look at this is to use enterprise value as a multiple of EBITDA. When doing so, the EV/EBITDA multiple of the three dollar stores averaged together is 22% higher than the Big Box discounters at 8.5 times. Value investors, especially deep-value ones, would balk at this type of multiple. Why buy the flavor of the moment when you can own three of the best-run retailers in the world for less.

Supporters of the dollar-store craze surely will point to Dollar General’s fourth-quarter earnings report of March 22 that saw profits increase 32% year-over-year, to $0.87, five cents ahead of the consensus estimate. DG’s 6.5% same-store sales growth in the fourth quarter, well ahead of its fiscal 2012 growth rate of 3% to 5%, was impressive.

Further evidence that the momentum for dollar-store stocks will continue unabated is Dollar Tree’s Q4 report from February, which saw it increase earnings per share by 24% year-over-year, double the rate of its revenue increase for the quarter. Equally strong same-store sales growth of 7.3% seems to indicate that the industry as a whole is on autopilot. Dollar Tree’s stock is up 14% year-to-date as of March 23, its fifth consecutive year in the black.

What could possibly go wrong?

The contrarian in me believes that when a self-interested party such as KKR starts talking up the continuing value orientation of consumers, the jig is almost up. It’s much like the bullish/bearish sentiment of investment advisers. When they’re highly bullish, you should be selling, and vice versa.

As Warren Buffett likes to say: “When people are greedy, be fearful.” Dollar-store investors are pretty greedy at this point in the economic cycle. So it’s time to get off this train.

As of this writing, Will Ashworth did not own a position in any of the stocks named here. 

Article printed from InvestorPlace Media,

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