Editor's Choice

Are These Discount Stores Really a Discount?

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

I love discount stores. They've got the market expansion during bad times and there are always going to be deal-hunters during good times, so they've definitely got room to run. But I'm not about to plunk down my money (whether earning it was easy or hard) unless I can find a good deal. To me, that means a reasonably low price relative to either sales, profits, or book value relative to the industry as a whole. And as always, a decent dividend holds some weight.

Big Lots (NYSE: BIG) is a nice little number with the infamous "Fortune 500" warning sign attached to it. I tend to avoid companies that are already highly praised because they tend to get lazy once they've read their own press clippings. But Big Lots hasn't reached the "we're so big we need to pay a token dividend" level yet, and that's a good thing. I also like how Big Lots has made a business out of taking over old spaces and getting almost random stuff to sell. You may have a far different inventory one month versus the next there, and it's definitely an adventure going in there.

But does adventure lead to a good deal, or stepping in something nasty? I like the numbers on Big Lots -- it's trading for a little over 12 times earnings, a very reasonable 3.1 times book value and an industry-leading .4 times sales. It's also got plenty of room to grow because of the under $2 billion market cap. Unfortunately... I've got nothing. Big Lots seems to be a good store that's trading at good valuations. If you've got the stomach to accept that Big Lots may change just about anything tomorrow and that many of its locations are the rejects of other stores, go for it.

Costco (NASDAQ: COST) seems pretty cool at first glance. It's a bigger membership warehouse chain club than Wal-Mart’s Sam's Club, an impressive accomplishment in itself. With a .4 price/sales ratio that matches Big Lots and a reasonable price at 3.5 times book value, some of the numbers look good. And of course, I like that there is a dividend.

However, Costco also has issues. For example, the veal and pork crates their suppliers used to use bring up questions about the company's overall ethics. While they say the right things when there's a chance of getting caught, it's a rare company that doesn't investigate how their suppliers do things before signing on. And while Costco's people tend to be paid reasonably well, with non-management workers making up to $21 per hour, the employee agreement doesn't offer the kinds of protection that actual unionization would. I actually like unions, being a Teamster myself. So I wonder why Costco provides an agreement that simulates collective bargaining without providing all of its benefits.

Beyond the questions, some of the numbers aren't so handsome. Trading at almost 25 times earnings, I'm not seeing a great deal here. The market as a whole is trading for far less, and even in the discount variety sector that's pretty pricey. Considering that Costco is only rocking 1.8% profit margins, it's just too risky for my tastes because it seems likely to falter if anything goes wrong. While there is stability in the membership-based business model, I'd rather see the earnings go up or the price go down before taking a deeper look.

Family Dollar Stores (NYSE: FDO) amaze me. Their prices are high for what you actually get on a generic volume basis and paying cash can be irritating. How does a low-market chain charge more for the same stuff and manage to make enough profit to pay one of the higher dividends in the sector? 

I don't know. But I do know they're pretty good at it. Family Dollar is trading for around .7 times sales, a rather steep 4.8 times book value and a middling 15.5 times earnings, and they've been growing like a weed on steroids since the first store opened in 1959. I'm not exactly in love with Family Dollar's 4.4% profit margins; they're projecting 500 new stores this year. That's pretty ambitious.

However, even if all of those stores turn a profit the first year (which often doesn't happen the first year in retail) and every other store stays steady during the economic recovery (which it might not given the likelihood consumers will want to go higher end as they can afford to do so), that's only about a 6% growth rate. I don't have any real problem with Family Dollar, but I'm not seeing a great deal.

pongun has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Big Lots and Costco Wholesale. 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!

blog comments powered by Disqus