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Summary

  • There are concerns that the U.S. stock market is overvalued and due for a correction.
  • Smart investors will find safe investments that can withstand or even perform well during times of economic and political uncertainty.
  • Dollar stores tend to do better when there is an economic slump and their stock prices reflect this.

This year has been an unusual one, to say the least. U.S. GDP declined in the first quarter and estimates for the year have been cut. Despite the decline in growth, the markets have continually reached new record highs. As the market continues its bullish run, some investors are beginning to worry about a correction in the near-to-midterm future. On top of this, there are serious issues developing around the world; including the Iraq and Ukrainian crises, which threaten world oil supplies and natural gas supplies to the EU. With slowing growth expected, GDP shrinking, and several threats to global energy supplies looming, is it reasonable for Wall Street to be breaking record after record? Many, including myself, would say no, but I do not claim to know for sure if the market will tank, and certainly not when such a thing may happen. What I hope to do here is make one more aware of the gathering storm clouds and offer interesting investing ideas, Dollar Tree (NASDAQ:DLTR) and Dollar General (NYSE:DG), which can help lower your portfolio's risk.

Trouble in the U.S.

The U.S. was predicted to continue growing in the first quarter of 2014; however, a decrease of 2.9% was reported. Last week, the IMF slashed its estimate for U.S. GDP growth from 2.8% to just 2%. Despite the decline in GDP (and expected growth), the markets have continually reached new record highs (below). While many are still confident about the strength and prospects in the equity market, several billionaire investors (including Warren Buffett and George Soros) have been selling off tens of millions of shares of consumer products stocks and U.S. bank stocks. While this is certainly a cause for concern, some investors maintain that sticking to the fundamentals of finding good companies undervalued in the market will provide for stable returns in the long run. I agree with both, to an extent, the market is priced high and looks to be due for a correction, but there are companies out there that will continue to perform well and pay dividends through the hard times. These are worth investing into.

^NYA Chart

^NYA data by YCharts

In addition to the GDP issues in the U.S., the Iraq and Ukraine crises are threatening to increase world oil prices and the price of natural gas for Europe. Americans would need to pay more at the pump, and thus, have less to spend on retail and other goods.

Dollar Stores

With these issues in mind, I present two companies which not only have strong fundamentals, but also thrive when the rest of the economy goes south. They are Dollar Tree and Dollar General. These dollar stores (like all dollar stores) are very special, because they sell substitute goods. Whenever the economy enters a downturn and many jobs are lost and disposable income falls, people reduce spending in many aspects of life. However, there is still a need for many products, and when Wal-Mart (NYSE:WMT) becomes too expensive, dollar stores become the savior.

Due to this special quality, dollar stores not only increase sales and profits during economic downturns (such as the crash of 2008 and the recession of 2008-09), but their stock price also rises much faster than the general market. This can clearly be seen in the two stock charts below, going from 2007 to 2010 for Dollar Tree and from 2009 to 2012 for Dollar General.

(click to enlarge)

Source: Dollar Tree

Source: Dollar General

Perhaps what's most interesting is that in 2007, Dollar Tree's stock (top) was underperforming relative to the market, but after the crisis, it rose far above it at a faster rate. A similar trend is shown with Dollar General, though there is no stock information for the period during the 2008 crash. These stock prices reflected sales, profits and EPS, which all increased at an increasing rate from 2008 onwards. Their increasing sales coincide with the rise in U.S. unemployment. For Dollar Tree, sales increased 2.7% in 2007, while in 2009, sales increased nearly 13%. At the same time, EPS increased from $1.39 in 2007 to $4.03 in 2011. For Dollar General, sales of its predecessor were about $9.4 billion in 2008; these increased to $10.5 billion in 2009 (y-o-y increase of 11.7%). Its EPS for 2009 was $0.34, this increased to $2.22 FY 2011.

To be clear, I am not saying that there needs to be an economic crisis for dollar stores to perform well. Both Dollar Tree and Dollar General had been successful in increasing sales and number of stores almost each and every year from the 90s to the 00s. However, when there is a downturn, these companies' sales grow at a faster rate, while many other retailers see sales and profits decline.

Current Performance and Potential

Dollar Tree

Dollar General

Year

2012

2013

2012

2013

Sales

$7.39 Bn

$7.84 Bn

$16.02 Bn

$17.5 Bn

Operating Profit

$920 M

$970 M

$1.65 Bn

$1.74 Bn

Net Income

$619 M

$600 M

$950 M

$1.03 Bn

EPS

$2.68

$2.72

$2.85

$3.17

ROA

24%

22%

9%

10%

Current P/E

19.13

19.17

The chart above shows the main financial results and revealing ratios of the two companies. It's clear that even as the U.S. economy is in recovery (gaining 150+k jobs per month) and unemployment decreases, these two dollar stores have continued to increase sales and profits. Healthy EPS, high positive cash flow from operations and a medium-level P/E ratio make both these companies attractive for a long position.

Conclusion

The underperformance of U.S. GDP, coinciding with rapidly rising energy prices could hit disposable income hard, and thus hurt consumption in other areas. Europe is also struggling with many more problems than the U.S., and now may face a rise in the price of natural gas, along with oil. These worldwide events/issues present a risk to the fragile economic recovery. With the market at all-time highs, there are serious concerns of a possible correction in prices. While I do not know when, if, or how big a correction may be; I offer two stocks that can survive another recession or stock market decline; Dollar Tree and Dollar General. They are stable, established companies that perform even better in a downturn, and their stock price will outperform a bear market. Investing now would mean that at least part of your portfolio will be secure (to a reasonable degree) if the worst comes to pass.

Source: Dollar Stores: An Important Addition To A Risk-Adverse Portfolio