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It’s Hard To Discount This Type Of Performance

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Who would have thought that a company that sells things other stores don’t want could be such a good investment? I guess in hindsight anyone could have seen this, as The TJX Companies (NYSE: TJX) have been in the business for years. While The TJX Companies could be a good investment in its own right, the company I believe investors should check into immediately is Ross Stores (NASDAQ: ROST).

How Do You Sell This Much Of What Others Don’t Want?
There is something ironic about a company making plenty of money by selling items that department stores didn’t want. Generally speaking, The TJX Companies (specifically TJ Maxx and Marshalls) and Ross Stores have the same strategy. They hope to buy goods from other companies that they couldn’t sell at rock bottom prices. Then these companies put those same goods on the shelves at just slightly higher prices and shoppers come in droves.

The key for both The TJX Companies and Ross Stores is keeping their merchandise ever changing. This means selling items at prices so inventory turns over frequently. In this way, shoppers have to keep checking the store for new merchandise. This is a big part of what makes these companies different from companies like Kohl’s (NYSE: KSS) or Target (NYSE: TGT). Both Kohl’s and Target change out their selections, but generally speaking things are fairly static, and their prices are set and don’t change unless items just aren’t selling.

Tight Margins + Tight Expense Controls = Superior Results
One key reason investors should consider Ross Stores is because of their tight control of expenses. The line item of selling, general, and administrative expenses, has been the undoing of many retailers. When a company can’t keep its costs down, it’s hard to grow profits in a thin margin business like this.

Ross shows that they can control expenses because they spend the least on SG&A relative to revenues compared to their peers. In the current quarter, Ross’ spent just 14.25% of revenue on SG&A. By comparison, The TJX Companies spent 16.46%, Target spent 20.3%, and Kohl’s spent 23.74%. As you can see, Ross is the model for cost efficiency.

Growth, Growth, And Oh Yeah Growth
The company’s cost efficient operation is particularly impressive because they are expected to grow earnings the fastest of their peer group over the next few years. In fact, this is the second reason to add Ross to your Watchlist, the company’s expected EPS growth is 12.10%. Considering that Target and The TJX Companies are expected to grow by about 11%, and Kohl’s is expected to grow by 7.9%, Ross has a leg up on their competition.

A third reason to buy Ross is their performance suggests that analysts are right to expect strong earnings growth. Ross’ same-store sales increased by 3% on a year-over-year basis. This might not sound like a lot, but it was better than any of their peers. The TJX Companies finished just behind Ross, with a 2% increase, while Target saw a same-store sales decline of 0.60%, and Kohl’s saw a decline of 1.9%.

What do you get when a company has strong growth in sales, and good cost controls? You get the fourth reason to consider the stock, and that is Ross’ strong operating cash flow growth. I use a measure called core operating cash flow (net income + depreciation) to compare companies, and by this measure, Ross comes out on top again. The company’s operating cash flow increased by 12.55% versus last year. The only company to come close to this result was The TJX Companies with an increase of 8.08%. However, Target and Kohl’s fell far behind with increases of 0.86% and 1.69% respectively.

Growing Earnings And Cash Flow = A Better Dividend?
It shouldn’t be a surprise that Ross has a low free cash flow payout ratio. This low payout ratio, and the potential for further dividend increases is the fifth reason to consider the stock. In the quarter, Ross paid just 12.55% of their core free cash flow (net income + depreciation – capital expenditures). If you look at their peers, not surprisingly, The TJX Companies came in just behind Ross with a 24.12% payout ratio. While Kohl’s payout ratio was just 34.07%, even without Target’s Canadian expansion costs, the company’s ratio came in at 69.05%.

With Ross paying a yield of about 1% compared with 1.15% at The TJX Companies, 2.07% at Target, and 2.7% at Kohl’s, investors might dismiss the company at first. However, when you consider how little of their free cash flow Ross is paying out, this dividend should be able to increase significantly over the next several years.

In short, buying Ross gives you a fast growing company, with good organic sales and cash flow growth. The company’s free cash flow should provide a rising tide of dividends to investors in the future as well. This company might be a deep discount operation, but investors shouldn’t discount what this stock could do for their portfolio.

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Chad Henage owns shares of Target. The Motley Fool has no position in any of the stocks mentioned. 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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