In this article I use AAII’s A+ Investor Stock Grades to provide insight into three discount retailer stocks. With talks about an impending recession around the corner, is it time that you consider these three discount retail stocks such as Dollar General
Discount Retailer Stocks Recent News
A substantial barrier is what guarantees a company’s survival in the future. In this regard, the U.S. Census Bureau reports that out of the 19,500 officially recognized and incorporated towns across the nation, 15,000 have populations under 5,000 people. These towns make up the central customer base for discount retailers like Dollar General, Dollar Tree and TJX Companies. One of the key strengths of these companies lies in their extensive retail presence in low-income areas, creating a large moat to entry that many other retailers neither desire nor can establish.
How does the current state of this industry appear right now? Many consumer companies find themselves offering enticing deals to attract budget-conscious customers, especially as household finances become more strained. Recent surveys by NielsenIQ show that as of last month, approximately 30% of U.S. shoppers were opting for products on promotion, compared to just 17% back in January. During economic downturns or periods of decline, individuals tend to have reduced disposable income, leading them to gravitate toward stocks of discount stores, which typically perform well during such phases.
Although the U.S. boasts a seemingly favorable 3.5% unemployment rate as of July 2023 and an inflation rate of 8.0% in 2022, a closer examination reveals that nominal wage growth falls significantly short of expectations. Hourly wages have struggled to keep pace with productivity, with cumulative productivity surging by over 240% between 1948 and 2023, while cumulative hourly compensation only increased by 108% over the same period. The income gap provides a chance for customers with lower incomes to access discounted prices at bargain retailers.
For most discount retailers, the cost of customers switching to competitors is minimal, which subjects these companies to intense competition from convenience stores, large-scale retailers, deep discounters, grocery stores, pharmacy chains and online giants like Amazon
As the cost of living goes up and consumers opt for cheaper alternatives, many may seek more affordable options while shopping. Moreover, the ongoing expansion of technology and e-commerce presents an opportunity for discount retailers to streamline their operations and safeguard their profit margins from erosion.
Grading Discount Retailer Stocks With AAII’s A+ Stock Grades
When analyzing a company, it is helpful to have an objective framework that allows you to compare companies in the same way. This is why AAII created the A+ Stock Grades, which evaluate companies across five factors that research and real-world investment results indicate to identify market-beating stocks in the long run: value, growth, momentum, earnings estimate revisions (and surprises) and quality.
Using AAII’s A+ Stock Grades, the following table summarizes the attractiveness of three discount retailer stocks—Dollar General, Dollar Tree and TJX Companies—based on their fundamentals.
AAII’s A+ Stock Grade Summary for Three Discount Retailer Stocks
What the A+ Stock Grades Reveal
Dollar General is a discount retailer that offers food, home and apparel merchandise. While the company has one reportable segment, it splits its revenue into four distinct product segments: consumables, seasonal, home products and apparel. The company offers brands from manufacturers, as well as its own private brand selections with prices at discounts to brands.
Dollar General has a Momentum Grade of D, based on its Momentum Score of 22. This means that it ranks weak in terms of its weighted relative strength over the last four quarters. This score is derived from relative price strength of –28.4% in the most recent quarter, –11.1% in the second-most-recent quarter, –15.3% in the third-most-recent quarter and 8.0% in the fourth-most-recent quarter. The ranks are 18, 57, 29 and 77, sequentially from the most recent quarter. The weighted four-quarter relative price strength is –15.0%, which translates to a rank of 22. The weighted four-quarter relative strength rank is the relative price change for each of the past four quarters, with the most recent quarterly price change given a weight of 40% and each of the three previous quarters given a weight of 20%.
A higher-quality stock possesses traits associated with upside potential and reduced downside risk. Backtesting of the Quality Grade shows that stocks with higher grades, on average, outperformed stocks with lower grades from 1998 through 2019.
Dollar General has a Quality Grade of B, with a score of 76. The A+ Quality Grade is the average percentile rank of the percentile ranks for return on assets (ROA), return on invested capital (ROIC), gross profit to assets, buyback yield, change in total liabilities to assets, accruals to assets, Z double prime bankruptcy risk (Z) score and F-Score. The F-Score is a number between 0 and 9 that assesses the strength of a company’s financial position. It considers the profitability, leverage, liquidity, and operating efficiency of a company. The Quality Score is variable, meaning it can consider all eight measures or, should any of the eight measures not be valid, the valid remaining measures. To be assigned a Quality Score, stocks must have a valid (non-null) measure and corresponding ranking for at least four of the eight quality measures.
The company ranks strongly in terms of its return on assets and buyback yield. Dollar General has a return on assets of 8.2% and a buyback yield of 4.1%. The sector median return on assets is 1.1%, and for buyback yield, it is –0.1%. The return on assets indicates how profitable a company is in relation to its total assets. The higher the return on assets, the more efficient and productive a company is at managing its balance sheet to generate profits. However, Dollar General ranks poorly in terms of its change in total liabilities to assets, in the 22nd percentile.
The company has a Value Grade of C, based on its Value Score of 53, which is considered average. This is derived from a high price-to-book-value (P/B) ratio of 5.72. In addition, Dollar General has a Growth Grade of A based on a strong five-year earnings growth rate of 10.0%.
Dollar Tree is an operator of discount variety stores whose business segments include Dollar Tree and Family Dollar. The Dollar Tree segment is the operator of discount variety stores offering merchandise predominantly at a fixed price. Its stores are operated under the brand names Dollar Tree and Dollar Tree Canada. It operates 15 distribution centers in the U.S. and two in Canada. The Family Dollar segment operates general merchandise retail discount stores in neighborhood settings. The Family Dollar segment consists of its store operations under the Family Dollar brand and 11 distribution centers. The Family Dollar stores segment consists of consumable merchandise, hardware, automotive supplies, diapers, batteries, pet food and supplies, seasonal and electronics merchandise, as well as apparel and accessories merchandise. It also owns trademarks, including Family Dollar and Family Dollar Stores.
The company has a Value Grade of C, based on its Value Score of 46, which is considered average. Dollar Tree’s Value Score is based on several traditional valuation metrics. The company has a rank of 34 for shareholder yield, 32 for the price-to-sales (P/S) ratio and 69 for the ratio of enterprise value to earnings before interest, taxes, depreciation and amortization (Ebitda). The company has a shareholder yield of 1.8%, a price-to-sales ratio of 0.92 and a 14.8 enterprise-value-to-Ebitda ratio. The price-to-book ratio is 3.04, which translates to a score of 71. The Value Grade is the average percentile rank of the percentile ranks for the valuation metrics mentioned above, along with the price-to-free-cash-flow (P/CF) ratio and the price-earnings (P/E) ratio.
Earnings estimate revisions offer an indication of how analysts view the short-term prospects of a firm. For example, Dollar Tree has an Earnings Estimate Revisions Grade of C, which is neutral. The grade is based on the statistical significance of its latest two quarterly earnings surprises and the percentage change in its consensus estimate for the current fiscal year over the past month and past three months.
Dollar Tree reported a positive earnings surprise for second-quarter 2023 of 4.7%, and in the prior quarter reported a negative earnings surprise of –3.2 %. Over the last month, the consensus earnings estimate for the third quarter of 2023 has decreased from $1.28 to $1.02 per share due to 22 downward revisions. Over the last three months, the consensus earnings estimate for full-year 2023 has remained relatively flat at $5.974 versus $5.972 per share three months ago.
Dollar Tree has a Quality Grade of A with a score of 85. The company ranks strongly in terms of its buyback yield and return on assets. Dollar Tree has a buyback yield of 1.8% and a return on assets of 5.3%. However, Dollar Tree ranks poorly in terms of its accruals to assets, in the 45th percentile.
TJX Companies is an off-price apparel and home fashion retailer in the U.S. and worldwide. The company’s segments include Marmaxx, HomeGoods, TJX Canada and TJX International. The T.J. Maxx and Marshalls chains in the U.S. have a total of 2,482 stores. The HomeGoods segment encompasses 894 stores in the U.S. HomeGoods offers an eclectic assortment of home fashions, including furniture, rugs, lighting, soft home, decorative accessories, tabletop and cookware, as well as expanded pet and gourmet food departments. The TJX Canada segment operates the Winners, HomeSense and Marshalls chains in Canada. Winners is a family apparel and home fashion retailer in Canada. The TJX International segment operates the T.K. Maxx and HomeSense chains in Europe and the T.K. Maxx chain in Australia.
TJX Companies has a Value Grade of D, based on a score of 25, which is considered expensive. The company has a rank of 27 for shareholder yield and 57 for the price-to-sales ratio. The company has a shareholder yield of 3.2% and a price-to-sales ratio of 2.04. A lower price-earnings ratio is considered a better value, and TJX Companies’ price-earnings ratio is 26.7, compared to the sector median of 16.1. The enterprise-value-to-EBITDA ratio is 16.1, which translates to a rank of 73.
TJX Companies has a Quality Grade of A, based on a score of 96, which is very strong. The company ranks strongly in terms of its gross income to assets and F-Score. TJX Companies has a gross-income-to-assets ratio of 50.4% and an F-Score of 9. The sector median gross income to assets is 30.8%. TJX Companies ranks very strongly in terms of its return on assets, in the 93rd percentile.
TJX Companies has a Momentum Score of 86, which is Very Strong. This means that it ranks highly in terms of its weighted relative price strength over the last four quarters. This score is derived from an above-average relative price strength of 10.0% in the most recent quarter, –5.5% in the second-most-recent quarter, –3.7% in the third-most-recent quarter and 29.1% in the fourth-most-recent quarter. The ranks are 79, 67, 39 and 95, sequentially from the most recent quarter. The weighted four-quarter relative price strength is 8.0%, which translates to a rank of 86.
TJX Companies has a Growth Grade of A, based on a score of 90, which is very strong. The company has five-year sales growth of 6.8%, compared to the sector median of 5.9%. The company has an Earnings Estimate Revisions Grade of B, with a score of 65. TJX Companies has strong relative price strength in the most recent and second-most-recent quarters.
The stocks meeting the criteria of the approach do not represent a recommended” or “buy” list. It is important to perform due diligence.
If you want an edge throughout this market volatility, become an AAII member.