This Day On The Street
Continue to site right-arrow
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Cramer's Action Alerts PLUS - See his portfolio and get alerts BEFORE every trade. Learn more NOW!

Buffett's Dollar Store Bet Is Wrong: Opinion

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By James Brumley

NEW YORK ( StreetAuthority) -- Did Warren Buffett's Berkshire Hathaway (BRK.A) recently commit an error in judgment?

It's tough to be critical of one of the world's greatest value investors, but even the best of the best can occasionally get caught up in the hype and forget the disciplined rules that earned them their fortunes in the first place.

Warren Buffett

In question is Berkshire's bet on dollar stores via its potentially overpriced investment in Dollar General (DG).

To be fair, making a $48 million investment in a $15.6 billion company while its stock is trading at a high price-to-earnings ratio of 18 doesn't seem like a call Buffett would make. Instead, Berkshire's new manager, Todd Combs, probably made the pick.

Still, Berkshire Hathaway is Buffett's baby, and knowing how he likes to do things, the pick may not exactly be one that investors want to mirror. Here's why.

From Good to Great

Dollar stores and deep-value retailers such as Dollar General, Family Dollar (FDO) and Dollar Tree (DLTR) are new, but they really didn't reach their full stride until 2008. Prior to that time, consumers for the most part felt rich and acted rich, and didn't want or need to shop for bargains.

But once economic Armageddon struck, many consumers quickly made the switch and started shopping at these deep-bargain stores in order to save their hard-earned money.

And the numbers verify it. Between 2005 and 2007, Dollar Tree's bottom line grew by an average of 15% per year. Since then, its net income has expanded by a little more than 31% per year on average.

Dollar General's earnings growth since 2007 has been even more phenomenal. The company moved from what was essentially a break-even year in 2007 to per-share earnings of $2.37 last year, which isn't bad for a stock priced at roughly $46. Before 2008, Family Dollar's average annual earnings growth rate was 6%. Since then, it has averaged 23%.

By all accounts this is exactly the kind of growth investors love to see from the companies in which they've invested. And this new bargain-focused paradigm apparently is here to stay -- even during a stronger economy -- supporting this industry's earnings.

So why do I say Buffett and Combs likely made a big mistake in buying shares of Dollar General?

Because the stock wasn't even close to being cheap when they bought it. Although the earnings growth from this group of retailers has been red-hot for the past four years, the underlying stocks have appreciated even faster -- perhaps too fast.

Take Dollar Tree, for instance. Annual earnings now are 138% stronger then they were in 2008, but the stock has gained nearly 300% between then and now.

As a result, the price-to-earnings ratio has soared from a palatable 16.4 at the end of 2008 to the current 23.5.

And Dollar Tree isn't alone.

Family Dollar is the same story. Although EPS has grown from $1.66 in 2008 to $3.40 for the past four quarters as consumers have become loyal to the stores, the stock's price grew nearly 200% during the past four years.

And while the trailing P/E of about 18.6 makes it the cheapest among the three stocks in question, that's still an unusually high P/E for a retailer.

Dollar General wasn't a publicly traded company in 2008, but just for reference, earnings of 47 cents per share in 2008 swelled by an incredible 400% to reach $2.37 last year.

Since Dollar General went public in late 2009, the stock has roughly doubled, while income has only been 81% higher. The trailing P/E has moved up to a pricey 19.5.

1 of 2

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Try it NOW
Only $9.95
Try it NOW
14-Days Free
Try it NOW

Check Out Our Best Services for Investors

Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Options Profits

Our options trading pros provide over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • Actionable options commentary and news
  • Real-time trading community
Try it NOW
Try it NOW
Try it NOW
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
AAPL $126.60 0.15%
FB $80.00 -1.48%
GOOG $567.68 -1.33%
TSLA $193.88 -3.36%
YHOO $43.44 -1.63%


DOW 17,856.78 -278.94 -1.54%
S&P 500 2,071.26 -29.78 -1.42%
NASDAQ 4,927.37 -55.4390 -1.11%

Partners Compare Online Brokers

Free Reports

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs