Play the Pullback on Dollar General

Premier growth companies typically only get cheap when headline news makes traders nervous. That was the case on Thursday, May 31, 2018 after slight earnings misses from both Dollar General and its rival Dollar Tree sent their shares tumbling. Plunging prices can make for great opportunities if you like the underlying shares for the long term. Dollar General is an example of what I call a left to right stock. Those are companies whose shares climb year after year due to steadily improving fundamentals. DG certainly meets that criteria. It last came public on Nov. 9, 2009, at $21 per share. Earlier this year it hit an all-time high of $105.82. Patient investors couldn't help but make money as all major metrics expanded dramatically. DG's progress since 2010 is documented below. Note that FY 2018 numbers (FY ends Feb. 1, 2019) include estimates that reflect the company's late May, fiscal Q1 quarterly report. Continuous shareholders did quite well even when measuring from the current pullback. The news which sent the shares tumbling was not all that bad. DG is still expected to post all-time record profits for both 2018 and 2019. All the other metrics listed above are also on pace to establish new highs. Where is the bad news? Since 2010, DG has sold for an average multiple of 17.1x. Its typical yield, since DG started making cash distributions in 2015, has run about 1.25%. The stock is now offered at a discounted P/E along with a slightly better than average yield. A simple regression-to the-mean valuation, based on this year's EPS estimate suggests DG could recover to north of $102 within 6 to 12 months. Achieving that goal would provide about 16% in total return. That's not bad on a high-quality, proven growth stock. Look out 18-months, to the end of FY 2019, and $114 might be within reach. Independent analysis from Morningstar is in general agreement. They had rated DG as a neutral just before the latest earnings report. Morningstar does not provide 12-month target prices. It does, however, indicate that $93 appeared to be DG's present day fair value. Dollar General's retreat from $105 has squeezed out pretty much all the risk of owning the stock. Situations like this, where upside is just moderate but downside is low make selling long-term puts my preferred trading strategy. You'd be locking in worst-case, forced purchase prices well below the trade inception level while pocketing generous premiums up front. The screen shot below showed the actual last trade prices on DG's Jan. 17, 2020 expiration date $85, $90 and $95 put options. Getting exercised on DG at net prices from $75.80 to $82.00 would not be a scary proposition. The forward P/Es at those two levels would drop to either 12.6x or 13.7x DG's expected FY 2018 profits. Owning DG @ $75.80 would mean earning 1.53% in yield as well. The only other time the dividend reached that level was right at the low in 2017. Traders who bought in then saw the stock surge from $66 to $105. Maximum gains on these option sales would run from $920 to $1,300 per 100-share commitment. The top end of that range would be just as good as owning DG at $89.31 and riding it up to $102.31. Dollar General is a niche player in a growing market. Buy some shares, sell some puts or consider doing both.

Play the Pullback on Dollar General

Latest slide in shares has taken virtually all the risk out of this steady grower.

Columnist Conversation

This Weekend on Real Money

Friday Morning Fibocall for 9/18/2020

Wednesday Morning Fibocall for 9/16/2020

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.