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Dollar stores help many consumers stretch every buck, but with some consumers' wallets holding far fewer dollars, dollar-store stocks currently look overpriced.
At the onset of the recession, lots of investors thought consumers would "trade down" to Wal-Mart (NYSE: WMT ) . That was a logical theory, but many beleaguered consumers unexpectedly traded down even further, to dollar stores. Dollar Tree (Nasdaq: DLTR ) , Family Dollar (NYSE: FDO ) , and Dollar General (NYSE: DG ) , the three major names in the deep-discount dollar-store sector, all benefited from that ugly state of affairs.
Today, things could be getting so much worse for some Americans' finances that even dollar stores' sales and profitability will suffer. While Dollar General and Family Dollar missed earnings estimates in the latest quarter, Dollar Tree beat the analysts' best guesses. Still, all rivals were hurt by high transportation prices, as well as continued high joblessness, lackluster income, inflationary prices on essential food items, and the big money spent at the gas pump.
The dollar-store model's previous success has contributed to high multiples on these companies' shares. Dollar Tree, Family Dollar, and Dollar General shares trade at 20, 18, and 18 times earnings, respectively. By comparison, Wal-Mart and Target (NYSE: TGT ) both trade at 12 times earnings.
Even Wal-Mart has made it clear that its own core customers are struggling financially. That also means Wal-Mart's been aggressively trying to regain its price-cutting roots, putting even more pressure on the dollar stores' competitive outlook.
Right now, Wal-Mart shares look cheap, but that's still a risky bet, given its cash-strapped core customer demographic. Therefore, the premium prices attached to the dollar stores' shares look even riskier. If investors want the most bang for their investing bucks, they should avoid dollar stores' shares.
What do you think about dollar-store stocks? Are they worth buying now, or too pricey in the current environment? Add your two cents in the comments box below.