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Buffett, Ackman Buy Dollar Stores—Should You?

Hedge fund managers are getting bullish on dollar stores. Should you?

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William Ackman's Pershing Square Capital upped its stake in Family Dollar Stores as of June 30, according to a regulatory filing.

Ackman now holds about 11.1 million shares of Family Dollar, valued at $6.4 billion, up from about 10.9 billion shares prior to June.

In May, Ackman became the largest shareholder of the dollar store, saying that the company was poised for gains due to the potential of a buyout.

At the same time, Ackman also shed more of his stake in J.C. Penney. The filing showed Pershing Square reduced its stake in the department store by 18 percent to about 39.1 million shares.

Billionaire Warren Buffett also is showing an interest in the dollar store space, adding Dollar General to his portfolio. Buffett purchased a $50.8 million stake, or 1.9 million shares, according to a regulatory filing.

"Berkshire Hathaway's investment reinforces our belief that Dollar General has sustainable growth in sales, expense leverage, margins, EPS and market share," wrote AvondalePartners analyst Mark Montagna.

According to Montagna, both Dollar General and Family Dollar are showing a price advantage over retail behemoth Wal-Mart for back-to-school season. His survey of a basket of 30 back-to-school items at Dollar General was priced 10 percent below Wal-Mart's.

Montagna said he maintains his belief that Dollar General can grow earnings between 14 percent and 19 percent in the next four years.

"Dollar stores are the ultimate baby boomer play," said Wall Street Strategies analyst Brian Sozzi. "It says much about the future of baby boomers who still have much lower 401(k)s, and in the near-term, says the consumer recovery is very abnormal. Also, dollar stores are the quickest growers in the U.S., so get in now I suppose."

While the luxury space has certainly been a standout in recent months, as seen in the better-than-expected second-quarter results from Saks Tuesday, the high-end space is closely tied to the performance of the stock market.

Given the recent volatility, Goldman Sachs advised playing the dollar stores, which were favored in past market selloffs.

In the past two corrections, dollar stores saw same-store sales accelerate sequentially by 0.6 percent, more than offsetting margin pressure caused by increasing fuel prices in past periods, Goldman Sachs noted.

"With an 85 percent correlation to same-store sales and 58 percent correlation to year-over-year EBIT margins, luxury department stores are the most tied to the health of the stock market," according to Goldman Sachs. "This is somewhat intuitive as the high end usually spends based on mood versus means. In the past two corrections of 16 percent, these retailers saw an average sequential slowdown in same-store sales of 2.9 percent and EBIT margin contraction of 204 basis points."

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