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The main thrust of this analysis is concentrated in three parts. The first two parts are based on free cash flow (current and historical) and the third is based on historical price action as a gauge of investor sentiment.

The three methods used in this analysis are:

1) Price to Owners Earnings (OE) = Current and future analysis

2) Cumulative Owners Earnings (COE) = Historical analysis of owners earnings

3) Statistical Indicator Analysis (SIA) = Historical price action

For those new to this analysis please link here for an introduction: OE and COE, SIA, CapFlow.

The main goal of my analysis is first to determine a sell price. With that in mind, we attempt to buy the stock at half its sell price and then hold it for 5 years (provided that no macro- economic negative catalysts force us to sell). Due to the fact that we bought it at par, we can potentially achieve an average annualized return of 15% per year. This may enable us to double our money every 5 years. Occasionally we do find a stock that is not selling at par, but is actually selling at a discount. When this happens, gains are usually higher.

Analysis of Family Dollar (NYSE:FDO)

In the last few years, the management of FDO has done a wonderful job controlling costs and allowing the company to thrive during the recession. But now that we are exiting the recession, it will be interesting to see how they will do. Clearly when times are tough FDO does very well as they cater to the low and middle income consumer and operate a chain of 6,817 self-service retail discount stores in 44 states and the District of Columbia. Since they missed analysts' estimates this past week, I thought it would be a good time to analyze the company using my Mycroft Research System (MR) and see if the investor using my system could have gotten out in time.

Family Dollar Stores closing price at the time of this analysis is $43.90.

The following is a table housing Family Dollar’s Owners Earnings data from 1970-2010 (including estimates):

Click to enlarge

As you can see from the table above, FDO has been free cash flow positive for all the years under analysis (except 1974). This has allowed them to generate some $16.13 in owners' earnings per share from 1970 to 2010. They produced $32.85 a share in Cash Flow and spent $16.72 in capital expenditures, building up their chain of stores. So that $16.13 is what we call Cumulative Owners Earnings (COE).

Here is the Family Dollar Stores Cumulative Owners Earnings chart:

As you can see from the chart above, the last four years have been very profitable ones for FDO from the COE front, but unfortunately the company did not show consistency in growing their OE throughout their history and had some flat years (1992-2000 & 2002-2005) that deeply affected their COE. In the last four years they have made up for that in spades, growing COE more in those four years then they did in their previous thirty six. Unfortunately FDO still has a long way to go before their COE price gets in line with their market price. Since we like to sell at two times a company’s COE, our COE sell price for FDO is $16.13 X 2 or $32.26.

The next step for MR is analyzing a company’s Price to Owners Earnings (P/OE) and this is where FDO shows its real muscle. If you look at FDO’s table again you will notice for 2010, they are expected to have owners' earnings of $2.80. Since we like to sell at 30 times (P/OE), our sell price for FDO is $2.80 X 30 = $84 or close to twice what the stock is selling for. So now we have two out of the three sell results we need, let’s look at Family Dollar Stores' SIA:

The current SIA (red line) for FDO is $23.07 so again it seems that the stock price may have gotten ahead of itself. Always remember that the farther you move away from the SIA, the greater your risk as an investor, and the closer you get to par with or at a discount to a stock's SIA, the better it is for you.

As you can see at #1428 (January 3, 2008), FDO’s market price actually broke below its SIA for a period of exactly 15 days (January 3, 2008 to January 18, 2008) and then never looked back. The price of the stock went down to a low of $14.99 and its SIA on that day was $17.55. So someone watching FDO’s SIA number on a consistent basis would have noticed that the stock was selling at a 15% discount to its SIA.

If they had bought then, they would have made a 193% return on their investment in just two years. You would have also gotten a buy signal from the P/OE as it was trading at 10 times that number (since we like to buy under 15 times P/OE). Your COE would have been ok as well as you would have bought FDO at a 33% premium to its CDO. But the three sell signals, when added together and divided by three, would have signaled a strong buy.

The current SIA for FDO is $23.07 and we like to sell at 2 times SIA, so we have a sell price of $46.14.

So we have the three sell prices we need for our MR calculation and can now determine our buy price.

1) P/OE = $84.00 (30 times OE per Share)

2) COE = $32.26 (2 times COE)

3) SIA = $46.14 (2 times SIA)

Total = $162.40/3 = $54.13= Sell Price

Buy Price = $27.07

Conclusion = FDO is a weak hold according to our MR system.

It’s interesting that the FDO’s stock price hit an inter-day high of $51.81 on December 9, 2010 (96% of our sell price) before dropping - 15.26% since then, so we were real close on calling the top.

Disclosure: No Position in FDO

Source: Family Dollar Stores: Not Such a Great Buy