Dollar General (FY16 Q2 result)

Dollar General reported 2016 Q2 result that missed the analysts’ estimate and saw its share price punished by 17.7% fall to 75.48 in one day. When the market opened and it’s down 12%, I thought it’s a bit overdone, but I was even more surprised when it fell further at the market closing.

I bought it at 72.89 in September 2015. So, before this sharp fall, I was sitting on 25% paper return. I gave back nearly all my return in one day.

Analyst expectation aside, the reported performance wasn’t bad. Q2 revenue grew by nearly 6% yoy to 5.39bn, supported by new stores opening and +0.7% same store sales growth. The SSSG was mainly due to higher average transaction amount and offset by a drop in traffic to the stores. Q2 earnings grew by 13.6% from $0.95 to $1.08.

Since revenue and earnings were growing decently, why was the share price down so much? First, analyst expectation on revenue was $5.49bn. DG missed it by nearly 1.8%. As for the expectation on earnings, DG missed it by $0.01. Yes, that’s just one cent. So, in terms of Q2 performance, it’s not too bad.

The major concern by the market is DG’s slowdown in earnings momentum. For retailers, SSSG is the important metric. Market was disappointed with the SSSG of just 0.7%, which was below their expectation of 2.7%. The management highlighted weather, food deflation and reduced food stamps benefits as top line issues. Competition with other players was also intensifying. It’s this fall in confidence about the short term growth that drives the share price down so much.

I think Dollar General is fairly priced to slightly under-priced at current level. I will hold it for now. I may add to my position if the price falls further while the underlying economics of the business stay intact.

When I bought it at 72.89 in September 2015, it just came off from historical high. It wasn’t really cheap at that time, but I thought it has good business and management. It was also expanding aggressively by opening new stores. The ROA was around 9-10% and ROE 19-20%. It was creating value with existing stores and likely with new stores. So, I was willing to buy it at fair value.

Dollar General - Financials 10Y - 2016.PNG

Dollar General - Profitability 10Y - 2016.PNG


Two months after I bought it, it dropped to 60 and I was sitting on -17.5% paper loss. From -17.5% to +25% and back to square one in one year, it’s a decent roller coaster ride. This is not considered a high fluctuation though. In today’s market, many stocks behave that way. Fluctuation of 50% in one year (from bottom to peak or the other way round) is very common for liquid stocks. You should prefer stocks with very liquid market and higher fluctuation than lower fluctuation for the fluctuation provides you the opportunities to buy at low and sell at high, assuming you are able to estimate its fair value (and it’s right!).

Dollar General is a large cap stock and widely followed by many analysts, so its share price tends to be fairly priced or trade not far from its fair value. I am expecting 10% annual return for holding it over the years. To beat the average market return by investing in this stock, 1) DG has to outperform the market expectation, or 2) we buy it at below its fair value (when the market is pessimistic) and sell it at above its fair value (when the market is optimistic).

The return I expect from this stock is not high. Why don’t I aim for 20+% return by investing in other stocks with greater potential? Well, we can’t just look at the return alone. Return must always be associated with risk. If I’m able to earn 10% from a stock with lower than average risk, then I’ll be happy with the overall performance. If I aim for 20% return with much higher than average risk, then on a risk-adjusted basis, the performance may be just normal.

The market is obsessed with just the return alone, ignoring the risk. That makes stock investing a very challenging work. Fund managers are pressurized to earn higher return, and in the process, take on higher risk. However, higher risk does not mean higher return. Higher risk means it has the higher potential to earn higher return when favorable things happen. But when unfavorable things happen, higher risk will result in higher losses.

I have other stocks with higher growth potential. I also have other stocks with no growth potential in short term, but are underpriced by the market (I think). For Dollar General, I’m expecting a decent return with below average risk.


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