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Dollar Tree, Family Dollar Rake in Big Bucks

The retailers at the bottom of the food chain give Saks and Nordstrom a run for their money.

Investors, in prosperous times, might look down their noses at

Dollar Tree

(DLTR) - Get Dollar Tree Inc. Report


Family Dollar


as stores that occupy the bottom rung of the retail food chain.

But given the economic conditions, these bargain emporiums have now risen to "buy" status. (The companies' shares, that is, and -- well, maybe even the stuff they peddle for a buck a throw.)

Family Tree and Family Dollar stand as the only general multiline retail firms with "overall grades" from Ratings in the "B" range, qualifying as "buy" recommendations.

Retail heavyweights such as


(M) - Get Macy's, Inc. Report



(JWN) - Get Nordstrom Inc. Report


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find themselves burdened with "risk grades" in the "D" range. With "overall" marks in the "C" area, each is considered a "hold."



, along with upscale Nordstrom, recently suffered credit downgrades from Moody's. Ratings recommendation for Saks dwells in "sell" territory.

DLTR and FDO can best be described as establishments like


(MCD) - Get McDonald's Corporation Report

, but with the "Dollar Menu" extended to virtually anything that might be needed around the house.

Dollar Tree operates more than 3,400 variety retail stores in 48 states, while more than 6,500 Family Dollar Stores can be found in 44 states. Each sells most every item for an even buck.

Despite the economic slump, the consensus of analysts is that after-tax earnings per share of Dollar Tree will advance 7.1% in the current year while Family Dollar's will climb 13%. Next year, Dollar Tree's net is expected to grow 10.7%, while Family Dollar will expand 8.3%.

As can be seen in the accompanying table, each has attained a respectable return on equity of more than 18%.

Although the pair of retailers enjoy relatively low debt burdens, their prices of 15.1 times current estimated earnings per share (for Dollar Tree) and 16.5 times this year's expected net (for Family Dollar) are largely discounting their expected growth. The multiples of three times book for Dollar TreeR and 3.3 for Family Dollar also seem to fully reflect their projected earnings gains.

Dollar Tree's stock price has held up well over the past year, as other retailers have been hammered. Trading in the low $20s at the end of 2007, it has fluctuated in a trading range from the mid-$30s to the low $40s, with recent prices near the higher end of that range. Ratings' evaluation model quantitatively analyzes a company's valuation metrics, current financial situation and consensus expectations of future earnings growth. A broad range of fundamental and technical data is condensed into a single risk-adjusted composite mark. Grades for most companies range from A-plus to E-minus, with bankrupt firms assigned marks of F.

A "performance rating" grade for a stock is determined from analyzes of past performance and prospects for future returns. The model processes trends in sales, net income, projected earnings--based on analyst consensus estimates--and economic factors. Credit is given for stocks with low valuations, as measured by price/earnings ratios, price to sales and price to book, based on current stock prices.

A "risk rating" grade is determined primarily on the level of volatility of a stock's daily and monthly returns and by the company's financial stability, as well as economic factors.

Rarely will a stock have both a very high "performance rating" grade, and an unusually high "risk rating" grade. There is always a tradeoff between risk and reward, so stocks awarded the highest "overall ratings" grades from the Ratings are those that provide an optimal combination of performance and risk attributes.

Richard Widows is a senior financial analyst for Ratings. Prior to joining, Widows was senior product manager for quantitative analytics at Thomson Financial. After receiving an M.B.A. from Santa Clara University in California, his career included development of investment information systems at data firms, including the Lipper division of Reuters. His international experience includes assignments in the U.K. and East Asia.