A Bargain Store on Sale Now

11/21/2011 9:00 am EST

Focus: STOCKS

Shoppers across middle America have neither the money for high-end shopping nor the patience for frustrating big-box stores, which is where this discounter comes in, notes Carlyle Dunbar of Investor’s Digest of Canada.

A few weeks ago, I put gold mines and the US-European debt crisis on hold and ventured down to Washington, DC, skipping a deadline in order to do so.

I made a discovery: there’s no recession evident in the nation’s capital, although local papers say unemployment is high.

Then came confirmation from a news dispatch, saying metropolitan Washington now boasts the highest average household income in the US, surpassing even California’s Silicon Valley. Indeed, the median income in Washington is 68% above the national average.

Where better to get an idea of “government-city” prosperity than Tysons Corner Center, the 11th-largest shopping mall in the US. It’s home to all the upscale stores—Nordstrom (JWN) and Coach (COH), for example—as well as to specialty retailers like Levenger.

And there were plenty of shoppers at this suburban DC mall, even at L.L. Bean, which rates high in reputation, but isn’t what you’d view as a high-priced retailer. Nevertheless, investors would do well to look beyond suburban Washington to the recession-strained small towns and small suburbs across middle America.

There, you’ll find the dollar stores flourishing, even as low-price retailer Walmart (WMT) struggles to hold on to its growth momentum. With their thousands of walk-to locations of much smaller size than Walmart and its brethren, and stocking a variety of everyday-need products at low prices, dollar stores have been surrounding the big discounters—and winning.

Their investment appeal has been a theme in this column for several years. And they continue to grow strongly. One such player that I’ve previously recommended is Family Dollar (FDO).

It remains, in my view, the most attractive in its class. It has no debt, higher asset turnover than its rivals, along with the highest return on equity: 31%. It pays a dividend, with a current 1.2% yield. Its turnover (sales vs assets) is higher, indicating a more efficient operation.

Family Dollar’s rivals include Dollar General (DG) and Dollar Tree (DLTR). A fourth discount chain, 99 Cents Only (NDN), is likely being taken over. Indeed, there are competing offers for the company.

Dollar General is loaded with debt, having come out of a few years of private ownership. Neither it nor Dollar Tree pays a dividend.

Family Dollar is also more attractively priced than two other high-flying retailers: Costco Wholesale (COST) and Amazon (AMZN). Thanks to its ferocious growth, Amazon trades at almost 100 times expected earnings. Yet, with expectations so high, Amazon is bound to disappoint in the future.

Left out in all this is the star Canadian retailer, Lululemon (LULU). Now No. 1 in the Investor’s Business Daily 50 list, Lululemon is a specialty apparel retailer, definitely not in the style of Costco, Amazon, and the dollar boys.

Lululemon has only 137 stores, pays no dividend and trades at 39 times expected earnings. Emphasizing the new market upturn, all these retailers except Costco have bullish chart patterns.

Yet, Family Dollar still has the best investment quality and the most conservative valuation.

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