How High Can These Retailers Really Fly?

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Shares of discount retailers Dollar General (NYS: DG) , Dollar Tree (NAS: DLTR) , and Family Dollar Stores (NYS: FDO) all hit new 52-week highs yesterday. Let's look at how they got here and whether clear skies are ahead.

How they got here
You would have to live under a rock not to have noticed the damage the recession has had on Americans, and we're cutting back on everything we can. So it should be no surprise that deep-discount retailers are having a heyday as consumers trade down to lower-cost items. But to really see why dollar stores are doing so well, look at the first chart in Morgan Housel's analysis of unemployment found here. Those who make the least are struggling the most, making it a natural that the lowest-cost retailers are picking up business.

The irony of the trend toward dollar stores is that margins can be higher at dollar stores than they are at grocery stores or discount retailers. Family Dollar, Dollar Tree, and Dollar General all have higher operating and profit margins than Wal-Mart (NYS: WMT) , one of the best retailers in the world, and well below the low single-digit margins grocery stores usually have.

Family Dollar Stores0.67.6%8.6%17.2
Dollar Tree1.811.9%11.5%18.9
Dollar General1.110.2%13%15.4
Wal-Mart0.55.9%8.5%12.7

Source: Yahoo! Finance.

From a valuation perspective, Dollar General looks like the best stock of the bunch, leading the way in growth and having the lowest P/E of them all.

What's next?
So, can dollar retailers continue to rise in the current environment? I believe they can in the short term, but long term, I have my doubts. Family Dollar in particular isn't growing fast enough to justify its current price, and I don't think the trend toward low-cost retailers will continue forever. The economy is slowly recovering, and if Europe ever gets its act together, I think employment will improve and consumers will begin to trade up again.

CAPS members seem to disagree. Family Dollar and Dollar Tree have four-star ratings (out of five) while Dollar General has a slightly less impressive three-star rating.

Dollar retailers may indeed keep rising, but I prefer discount retailers like Target and Wal-Mart because they have a wider audience long term, and they pay consistently growing dividends.

For all of our Foolish analysis on these stocks, click here to add Family Dollar to My Watchlist; click here to add Dollar General; and click here to add Dollar Tree.

At the time this article was published Fool contributorTravis Hoiumdoes not have a position in any company mentioned. You can follow Travis on Twitter at@FlushDrawFool, check out hispersonal stock holdingsor follow his CAPS picks atTMFFlushDraw.Motley Fool newsletter serviceshave recommended creating a diagonal call position in Wal-Mart Stores. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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