Is Dollar General Stock an Underappreciated Bargain, or Should Investors Stay Away?

Dollar General (NYSE: DG) is facing a scenario that once seemed unlikely: poor performance. Its business model looks like one that could attract consumers in recessionary times and bargain hunters in improved economic conditions.

However, the stock has suffered as its core consumers, lower-income customers in rural areas, have less money to spend because of inflation. Consequently, the stock's current price has fallen back to 2017 levels.

Does that move downward make Dollar General stock a buy, or should investors continue to avoid the retail stock?

The state of Dollar General

Dollar General bills itself as "America's neighborhood general store." It operates over 20,000 locations across the United States and Mexico. It serves the ultra-discount market, with its primary demographic being rural consumers who earn less than $35,000 per year.

Unfortunately, while it continues to add locations and increase revenue, shareholders have had little reason for optimism.

The aforementioned rural, low-income demographic makes up over 60% of its revenue. This customer has suffered from inflation and has often had to turn to credit cards to meet basic expenses.

Additionally, while it attracts some customers from middle and higher-income households, they do not feel as much pressure as their core demographic. Thus, the company has had to spend more on promotional activities.

Nonetheless, investors may have some reason for optimism despite the bleak outlook. For one, the inflation rate, which once reached 9%, has fallen below 3%. Investors should always remember that retailing is a cyclical business, and the down cycle it has just experienced may have stopped worsening.

Moreover, the inflation situation has improved to the point that the Fed has recently started to reduce interest rates. Over time, that should spur the added economic activity that could offer relief to Dollar General's core consumers and leave higher-income bargain hunters with more money they can spend at its stores.

Results and projections

Looking at the financials, they seem to offer both bad and good news. Fortunately, the bad news looks to be primarily in the past. Despite the anemic 0.5% yearly increase in same-store sales, revenue for the first half of 2024 managed a 5% annual increase to just over $20 billion.

Unfortunately, that meant gross margins fell one percentage point to 30%. Also, because selling, general, and administrative expenses grew by 9% during that time, net income fell to $738 million in the first six months of 2024, down from $983 million in the same year-ago period.

The company expects sales growth to stay in the 5% range through 2024. However, analysts forecast that net income will see a turnaround by 2025, when earnings grow by 9%.

With that improvement, Dollar General looks increasingly like an excellent value stock. For one, the dividend, which now stands at $2.36 per share annually, offers a dividend yield of 2.7%, more than double the S&P 500 average of 1.3%.

Also, its P/E ratio has fallen to 14, near multi-year lows and well below the 10-year average of 20. Although the lower valuation is indicative of some added risk, the discount could make the stock inexpensive enough to compensate prospective shareholders for that potential danger.

Should investors buy?

Ultimately, the current value proposition indicates that Dollar General stock is a buy. For one, Dollar General investors can buy the stock at approximately a 30% discount from average valuations. Secondly, Dollar General's sales continue to grow, indicating it continues to offer what its consumers want, even if they cannot buy as much as they would like for now.

Finally, the 2.7% return on the payout pays shareholders to wait for a probable recovery. These conditions should allow investors to claim returns on both dividends and growth over time.

Should you invest $1,000 in Dollar General right now?

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Will Healy has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.