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Carnevale: Ross Stores a Buy on Bad News (Update 1)

When a stock can be purchased within a reasonable range of fair value, then long-term earnings growth will be the primary driver of capital appreciation. Additionally, since dividends are paid out of earnings they are also functionally related to the company's profits and the growth thereof.

When you examine the long-term performance of Ross Stores, you discover that capital appreciation of 18.6% per annum correlates closely with the company's 17.1% earnings growth rate, adjusted only by valuation discrepancies.

Moreover, by examining the dividend cash flow table within the performance report, we discover that dividends have grown in close concert with earnings over time. Consequently, shareholders have received a raise in pay each year because Ross raised their dividend each year.

Therefore, even though Ross offers a below-market current yield, its growth yield (a.k.a. yield on cost) generated significantly above-market cumulative dividend distributions. Since 1999, a $1,000 investment in Ross Stores generated $523.73 worth of dividends compared to only $227.46 from the S&P 500.

The consensus of 31 analysts reporting to Capital IQ forecast Ross to continue growing earnings at 13.9% for the next five years. Personally, I feel the company can do better than that, evidenced by the fact that their earnings growth rate since the great recession of 2008 has averaged 25.9 % per annum. Since this is almost twice the consensus forecast, earnings growth somewhere between consensus and their historical average is at the very least plausible.

Summary and Conclusions

Clearly, Ross Stores is an extremely well-run retailer with a strong history and a bright long-term future. After being overvalued for much of 2012, Ross's share price has reverted to the mean and moved back into fair value territory. Moreover, I believe that the recent precipitous one-day drop in their share price has created a bargain for their shares that might be the equal to the bargains found by shopping in their stores.

Consequently, I think Ross Stores represents an excellent opportunity for the long-term investor seeking above-average growth and rising dividend income, coupled with a margin of safety based on current valuation.

Ross closed friday at at $56.20, up 97 cents or 1.76%.

At the time of publication, Carnevale was long ROST, although positions may change at any time.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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