2023-04-23 23:31:12 ET
Summary
- Dollar stores provide a defensive play against a backdrop of economic uncertainty.
- Dollar General, Dollar Tree, and Five Below are the main three competitors in the market.
- Dollar General is the best-performing company and is the best value at current valuations.
- If you are looking for a good defensive stock to hedge your portfolio, then Dollar General provides a good option.
There is a common saying in sports that defense wins championships. There is a time and a place in a portfolio for defensive stocks. Especially when we are still seeing high inflation and the Fed attempts to provide a soft landing for the economy. This is probably a good time to look at some stocks that perform well when most everything else is not.
Dollar General ( DG ), Dollar Tree ( DLTR ) and Five Below ( FIVE ) fit within this defensive category. When budgets get tight consumers start to look to save some money. We have already seen this occurring within the economy. We have seen an increase of higher income earners heading to Walmart to try and cut back on expenses. This same principal benefits dollar stores and other discount or budget retailers. The dollar stores should benefit from the uncertainty within the economy. The question then becomes which dollar store is the best option to include within your portfolio.
Historical Performance in Down Market
First off I thought we would compare and see whether or not historically dollar stores do perform well during a recession or a down market. It is not necessarily the case that a down year in the stock market means that there was a recession. Those two items are not one in the same. The stock market can have a negative year but the economy might not be in a recession.
Recessions in and of themselves can become a bit of a question mark. In general a recession is a decline in economic activity that lasts for months or even years. The National Bureau of Economic Research (NBER) is recognized as the authority that defines the starting and ending dates of US recessions. The NBER defines a recession as "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales". There are definitely some gray areas in defining a recession. What is considered "significant" or "spread"? A common rule of thumb is that two consecutive quarters of negative GDP growth means a recession. The NBER's definition is much more flexible than the general consensus of two consecutive quarters of negative GDP growth. Naturally, as with most things related to economics, this can become political. A recession is a black eye for any political administration so avoiding a "recession" is a priority.
I think the best way to compare the performance of dollar stores as a defensive stock is to look at the years of negative returns of the S&P 500 and see the results of the dollar store stocks during those same years. These down years in the stock market can directly correlate to a recession as well. At the end of the day what matters with a defensive stock is does it perform well when other stocks perform badly. Regardless if the economy is in an official recession or not we want a stock that will perform.
There have been 5 negative or 0 return years on the S&P 500 since and including 2008. Before that we jump back to the dot com crash that started in 2000 and carried through 2003. We could also compare the Nasdaq, Dow, or NYSE. Each of these are going to have different returns over different periods. I am going to use the S&P 500 for the benchmark since I feel this is the most widely used index to gauge the stock market as a whole.
The chart below outlines the returns for the S&P as compared to the 3 dollar stores and the difference in the return of each. All data is taken from macrotrends.com . They adjust historical data for time series analysis. This takes into account dividends, stock splits, among other considerations. There can also be small deviations depending on your source data.
Year | S&P Return | DG | Delta | DLTR | Delta | FIVE | Delta |
2022 | -19.44% | 5.6% | 25.00% | 0.65% | 20.09% | -15.66% | 3.78% |
2018 | -6.24% | 17.6% | 23.79% | -15.83% | -9.59% | 48.50% | 54.74% |
2015 | -0.73% | 2.9% | 3.61% | 9.72% | 10.45% | -21.89% | -21.16% |
2011 | 0.00% | 34.1% | 34.14% | 48.20% | 48.20% | ||
2008 | -38.49% | 60.84% | 99.33% | ||||
2002 | -23.37% | -20.51% | 2.86% | ||||
2001 | -13.04% | 26.16% | 39.20% | ||||
2000 | -10.14% | -24.13% | -13.99% |
I think the data provided is enough to make the determination that these stocks do outperform when the market sees a decline. It is not fully conclusive though. DG has outperformed in the last 4 market declines. DLTR has a longer history and they have outperformed in 6 out of the last 8 drops. FIVE is the youngest and has outperformed in 2 of the last 3.
Now as stated these market declines do not necessarily correlate with a recession. I think you would see these companies outperform even more so during a recession rather than just a market pullback. We had a 2 month recession during COVID. I feel that is a bit of an outlier as it was a self-induced recession that shut most business down. It was also for a 2 month time period. The market for the year also showed a solid return. It would be difficult to ever extract solid data from that 2 month recession. Especially due to the circumstances around the recession. The recession prior to that would have been 2008. The only data point we have for this is with DLTR. The company outperformed the S&P by nearly 100% during that year. The previous recession was 2001 and once again we have one data point with DLTR. During that year it outperformed the market by over 39%. During the year of the last two recessions DLTR has drastically outperformed the market as a whole. We don't have more data points with the other companies but it is a pretty strong positive for DLTR.
Dollar Store Comparison
There are 3 main dollar stores within the US. Two of them DG and DLTR are by far and away the two biggest in the market. FIVE is coming in a distant third place in terms of market share. I wanted to do a comparison between the three and see which one is the best option to potentially include within your portfolio.
Dollar General | Dollar Tree | Five Below | |
Market Cap (billions) | 47.81 | 33.4 | 11.28 |
Stock Price | 218.22 | 150.99 | 200.59 |
Dividend | 1.08% | 0% | 0% |
Locations | 19,304 | 16,340 | 1,340 |
Growth in Locations | 5.0% | 1.6% | 11.2% |
Revenue (thousands) | 37,844,863 | 28,331,700 | 3,076,308 |
YOY Revenue Growth | 10.6% | 7.6% | 8.0% |
EPS | 10.68 | 7.21 | 4.65 |
EPS Growth | 5.0% | 24.3% | -6.1% |
FCF (thousands) | 423,973 | 361,000 | 62,972 |
P/S | 1.3 | 1.2 | 3.7 |
P/E | 20.4 | 20.9 | 43.1 |
Based upon the current valuation I think that Dollar General is the best buy of the trio. It seems to be the creme of the crop in terms of performance. It also seems to be the most cheaply valued of the three at the moment. I would not consider any of the three stocks to be undervalued at their current levels.
DLTR is much closer in size and has a closer valuation to DG. Five Below is currently at a much higher valuation. The P/S ratio is triple that of the other two and the P/E is double. I don't see the justification in the much higher valuation for FIVE. It is a much younger company and is still growing. It is adding locations at a higher pace, on a percentage basis, than the other two companies. The revenues are not growing as fast as DG and barely any more than DLTR. This is due to scale where the other two add many more locations even if it is a smaller percentage. I don't see the growth numbers justify the higher valuation over either of the competitors. Five Below is not a bad company, it is just too richly priced at the moment compared to competitors.
Dollar General and Dollar Tree are much more closely aligned on the current valuation multiples. I prefer Dollar General for a few reasons. It has the strongest revenue growth for the past year. It is adding locations at a higher pace than DLTR. It is planning to continue its expansion as well. It is slated to open 1,050 new stores in 2023. DLTR plans to open around 650. I would expect DG to continue growing revenues at a higher rate due to the additional locations. They are very closely valued on a P/S and P/E ratio. Yet, DG is growing locations and revenues at a faster pace, all while building off a larger base. If anything you would expect to see a slightly higher valuation for DG due to its higher growth.
DG is the only one of the three companies to pay a dividend. While it is not a large dividend it shows the company is serious about returning cash to investors. The way I see it DG is the best performing and is the best value of the three dollar stores.
Risks
There are risks with any investment and any of these three stocks are no different. The idea behind the purchase of these three stocks is that they are defensive in case of a market downturn. If the market and/or economy continue to climb then the defensive trade is not likely to play out as well. Any of these three stocks have the potential to underperform in the case of the market climbing as a whole.
While I consider DG to be the best of the three and a good option for a defensive stock in your portfolio, I do not think it is cheaply valued. It is the best value of the three, but I don't think any of the three stocks are cheap. I think the price of these stocks shows that many investors are already in the defensive trade on these stocks. If the market climbs and investors become more confident it is likely that many investors will get out of the defensive stocks and you are likely to see these valuations contract.
That being said I do not think there would be a serious contraction in the stock price for DG. It is not cheap but I would not consider it overvalued either. I see small downside risk on the stock.
Conclusion
The economy and market are navigating a tough time right. We have seen stubbornly high inflation over the past year. The Fed is attempting to navigate bringing inflation down without sending the economy into a recession. It is not a bad idea to have some defensive stocks in your portfolio to help hedge against an overall market decline. Dollar stores are defensive stocks. During a recession many are tightening their budget and looking for cheaper items. This is a positive for discount retailers like dollar stores. I think that Dollar General is the best of the dollar stores. It is showing the best growth and valuation. I consider it the King of the Dollar stores.
I do not currently own any shares of the three companies. DG is the dollar store company that I would buy at the moment. I think it is currently fairly valued. I am concerned as many investors are about the economy. I have been watching DG and may enter if a good entry point emerges.
For further details see:
Playing Defense With Dollar General