Compare Discount Store Stocks – Part II

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 << Read More: Compare Discount Store Stocks – Part ILast week, we started to compare discount store stocks, namely Dollarama (DOL.TO), Target (TGT), Costco (COST), and Walmart (WMT). In that first part,  we completed the first three steps of our stock comparison process:

After reviewing each company’s business models, analyzing its dividend triangle metrics and their trends, and looking at the growth vector, we often get very excited about them and we want to buy! Not yet. It’s time to get back to earth and imagine what could go wrong. Below, we complete the comparison and reach a conclusion.
 4- Potential risksEvery company has flaws, and we need to identify them to compare the stocks. We often find similar risk potentials for companies in the same industry.  Here is a summary of potential for our discount stores.Being aware of the growth vectors and potential risks gives you have a better idea of the type of growth that appeals to you and the type of risks you’re willing to assume. We see that there are no “perfect” stocks, but this process helps you line-up stocks by order of your conviction level.
 5- Dividend safety and growthThere’s no point in investing in a company that’s about to cut its dividend.  You want to ensure that dividends are sustainable. Metrics to review include the payout ratio and cash payout ratio.Looking at the stock comparison tool below, we see  that all four company have payout ratios that are under control except for Costco’s cash payout ratio. After digging a bit, we see it’s due to its recent special dividend payment. COST’s payout ratio goes up like crazy each time it issues a special dividend.As for the others, DOL has a very low payout ratio suggesting that its dividend growth policy central to  its capital allocation. There’s no surprise in such a yield from COST. TGT and WMT show prudent capital allocation with ratios between 40% and 50%. It’s sustainable and likely to continue increasing. No surprise here as both companies show 50+ consecutive years with a dividend increase!
 On to dividend growth!Compare the annualized dividend growth over one, three, and five years of each company. Dividend growth is essential for your dividend income to at least cover inflation. A growing dividend often points to a company that’s doing well and confident about its future.Below are the annualized dividend growth rates for the discount stores stocks. We also show the dividend growth potential used in the DDM valuation model.Numbers tell part of the story, but the trend tells you where the dividend is heading. The earlier dividend triangle graphs are handy. We highlighted the difference between TGT and WMT EPS and dividend earlier in this post. A good combination of numbers and graphs will tell you the entire story.
 6 – ValuationA hotly debated topic among investors is how to assess the value of a stock. I use valuation models to compare stocks, not to determine if they’re undervalued or not. Because, to be honest, your guess is as good as mine.However, if you use valuation tools and apply them to two, three, or four companies in the same sector, it’ll be easy to identify which one best fits with your valuation methods.I use the P/E ratio trend over 5 years along with the Dividend Discount Model (DDM). I compare each company’s Fwd PE ratio to its 5-year average PE ratio. A Fwd PE below the 5-year average shows less enthusiasm for the company than in the past; could be a good time to invest. Looking at the P/E vs. the average 5-year P/E, we see that DOL and WMT are trading in line with their average valuations, TGT is trading at a small discount, and COST looks like it’s trading at a premium. It’s not a perfect analysis, but it could lead you to wait before buying COST if you are looking for a low-yield, high-growth candidate.The DDM value is of not help for low-yield stocks like DOL and COST. DDM is based on dividends only and can’t give a relevant valuation for such low yield. What is surprising is how TGT is “overvalued” as the $160.66 stock price should be $90 according to the DDM. The valuation is on the spot for WMT.
 The verdict: not always black & whiteA stock comparison often identifies a clear winner, or losers that we should not buy, but not every time. I knew that with these four companies we’d likely and up with an analysis showing that all could fit very well in a portfolio.However, the process is still helpful in such situations. It helps identify which stock to pick for growth and which to pick for income / stability. Conclusions:

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