Premature Sell-off Creates Value & Upside in These Three Stocks

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On Tuesday shares of Dollar General (NYSE: DG) traded lower by nearly 8% after guidance was what some analysts called a “head scratcher.” The loss was felt throughout the industry as rivals Family Dollar (NYSE: FDO) and Dollar Tree (NASDAQ: DLTR) traded lower as well. Now with all three stocks significantly lower is it possible that any are a buy?

A Look at Dollar General’s Earnings

If you look at the top and bottom line for Dollar General’s earnings you might wonder why it traded with such a loss. The company beat its bottom line expectations and posted sales growth of 10% year-over-year. However, it was the numbers and words spoken within the earnings report that spooked investors.

Strangely enough, the company raised its outlook for comparable sales, but then lowered its estimates for operating profits. This implies that the company has to mark down the prices of its products in order to stay competitive in the space. Furthermore, the company will begin to sell tobacco, following the footsteps of its rivals.

Dollar General Creates an Industry Burden

The reaction following Dollar General’s earnings was quite strange. The earnings weren’t great, but then again the stock had already seen a near 10% decline from its all-time high earlier this year. Therefore, the stock was not priced for perfection. Nor was Family Dollar or Dollar Tree, which also saw heavy selling pressure on Tuesday.

In early October, Dollar Tree revised guidance to the low end of its range. The stock was of course punished, but has slowly attempted to recover in the last couple weeks. However, the news from Dollar General created panic and the stock gave up most of its recovered value, 3.70%. The stock is now trading with a six month loss of nearly 30%, after trading higher by more than 275% in the five years prior.

Family Dollar operates a business that is very similar to Dollar General, and it actually lost more value on Tuesday, 8.36%! Both companies tend to face similar economic challenges and or thrive at the same time. Therefore, weakness for Dollar General indicates weakness for Family Dollar. However, there is no reason that Family Dollar would trade lower than Dollar General; perhaps it was due to pessimism after Dollar General announced plans to sell tobacco.

Are the Dollar Stores a Good Value Investment?

It’s important to first understand that although Family Dollar and Dollar General share similar business models, Dollar Tree does not. The Dollar Tree sells everything for $1, while the other two have more of a supermarket setup. Therefore, Dollar Tree does have its own identity, and an edge over the competition. In terms of value and pricing, it trades at just 13.47x next year’s earnings, with a price/sales of 1.26. As a result, when taking into consideration its recent loss, along with continued growth and expansion, I definitely think it’s a stock to buy on the weakness at some point this week.

As I said, much of Dollar General’s earnings were positive, but investors only dwelled on the negatives. Furthermore, the stock’s reaction leads you to believe that it was overpriced from the start, but that is not the case. Dollar General is trading with even better metrics than Dollar Tree, at 12.86x next year’s earnings and a price/sales under 1.0. Family Dollar is just as cheap, with a price/sales of 0.87 and a forward P/E ratio of 13.42, making it a good value buy as well.

When you take the deep value being presented in both companies into consideration, and combine it with the positives from the earnings report, I believe that both FDO and DG are presenting deep value. On Dollar General’s conference call it said that it plans to open 635 new stores in 2013, including 20 Dollar General Market stores. The company also said that total square footage will increase 7%, it will improve inventory controls, and the decision to sell tobacco should boost sales. These are all positives that weren’t considered during the sell-off, therefore in my opinion making the stock very attractive as an investment. Bottom line: All three of these companies fell prematurely without considering the upside, were already priced cheap, and should return nice gains as long-term investments.

BrianNichols has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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