To define a stock or sector as expensive, one must be familiar with fundamental analysis. While the nominal price of AAPL, for example, may seem expensive…the real future earnings power, forward and trailing P/E multiple, cash net of debt, and other metrics make it an attractive buy…according to some. This same type of analysis can be done to any sector or stock. Viewing the stocks of interest against traditional retail is an interesting exercise. WMT, TGT, and SWY were each given an equal weight in a basket against the dollar stores (33% each-FIVE was excluded because the example needs price performance over 2 years); see chart 1.

The chart below clearly displays the obvious outperformance, but also a narrowing gap between the two. This could be a real time indicator of the consumer. Spenders may be ‘upgrading’ to middle tier retail from the lower. The most conservative of the dollar discount group is arguably DLTR. Dollar Tree is very active in the share retirement department. Outstanding shares have decreased 14% since 2008, making EPS look even better! The cash flow statement confirms this, for the largest item over the last two years has been the common stock repurchase section under financing activities. These actions however have choked off net cash flow or net change in cash; but free cash flow, a metric that displays cash generated after spending money required for expanding its business, has raged 25% higher in 2012 from $340m to $437m. Consistently putting up figures like this could lead to multiple expansions.

DLTR currently trades as 21.5x TTM, but the analyst community seems to be mixed, for the median PE on next year’s EPS is at roughly 17x. Depending on your economic forecast, the implied thesis behind next year’s low multiple could be a booming economy and a trade down away from DLTR or maybe even inflation. The bottom line in all these analyst reports is always the price target. Here the average target is back to $54. The average target over the estimated EPS for next year yields a 19 multiple, more in line with where shares are trading now.

This has clearly been a hot sector for economic and fundamental reasons; and is one investor’s should keep a keen eye on.

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mark@keeneonthemarket.com