Two Stocks for a Slow Economy

My Mini Vacation

The Slow Economy

Two Stocks for a Slow Economy

Last week, my wife and I decided to get away and to celebrate my birthday a few days early. Actually, today is my birthday, but I don’t feel any older (or wiser).

Our trip to Key West was delightful. We took the ferry from Fort Myers to Key West, left our car behind, and brought our bikes for transportation. Key West is only four miles long, so getting around the island by bike was easy, except maybe for the 95 degree heat and high humidity.

We went to the beach, had a couple of beers at Sloppy Joe’s (a famous landmark that was Ernest Hemingway’s favorite watering hole), ate at several distinctive restaurants and enjoyed the one-of-a-kind atmosphere of Key West.  But meeting the colorful characters who visit or inhabit the island made our trip even more worthwhile.

We met a guy from Tennessee who literally abandoned his family, which included his estranged wife and two grown sons. He chose Key West to get away from it all; hopefully he will realize his mistake and rejoin his family soon. We found him to be well educated, with enough money for food, a cell phone and a bike, but he still slept on the beach every night! His family calls him occasionally to let him know they still care about him, so perhaps this refugee from responsibility will eventually come to his senses.

We also met a man, Billy, in his early 50s from Pennsylvania who had lots of money, although he was reluctant to tell us about his good fortune. He is a high school teacher who enjoys traveling to the Keys during the summer to dive for sunken treasure for Mel Fisher’s Treasures.

After Billy graduated from college in 1984, he was hired by Mel Fisher who needed experienced divers. One year later on July 20, 1985, Billy was on the diving crew that discovered the Atocha, the Spanish galleon that sank during a hurricane on September 6, 1622, near Key West.

After 16 years and 100 court battles, Fisher and his crew finally were able to claim as theirs the richest known cache of recovered sea treasure. The Atocha “Mother Lode” included 40 tons of silver and gold with over 100,000 Spanish silver coins, gold coins, Columbian emeralds, silver and gold artifacts and over 1,000 silver bars.

Billy, at the time only 24 years old, was well rewarded with silver bars, each weighing 70 pounds. He still has some of his silver bars stowed in his safe deposit box in Pennsylvania. Billy didn’t invest in stocks during the past 25 years, although he thought about it. He focused on the price of silver and made partial sales when the price was right.

The moral of the story isn’t to invest in stocks and hope for a miracle. Rather, perseverance will pay off eventually. Mel Fisher and his crew spent 16 years with the same focus. If you focus on investing wisely, your financial goals will be fulfilled, too.

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The economy’s woes have grabbed more than a few headlines lately. The economy has officially slowed in the U.S., Japan, the U.K. and elsewhere. The U.S. economy, as measured by the Gross Domestic Product (GDP), rose 1.8% during the first quarter of 2011, its seventh quarterly increase in a row. The growth of the economy is slow by most standards, and I believe unemployment won’t fall until GDP increases by 3.5% or more.

I expect the U.S. economy to remain sluggish for an extended period of time, probably two years or more. Am I bearish on the stock market? Not at all. In fact, many stocks could perform very well while the economy dawdles along.

Most big companies derive a lot of their sales from foreign countries. Many countries around the world reported rapid GDP growth for the first quarter of 2011. China grew at a 9.7% pace during the first quarter, India 7.8%, Indonesia 6.5% and Mexico 4.8%. Companies with large overseas operations will continue to provide solid growth in 2011 and 2012.

Other stock sectors that provide opportunities when the U.S. economy is suffering include discount retailers, pawn shops and payday lenders.

Several companies should perform quite well during the next few months, even though I expect the stock market to trend somewhat lower. Dollar Tree and EZCORP are among my favorites.

Dollar Tree (DLTR)
operates 4,177 general merchandise stores in 48 states and four Canadian provinces, many of which offer all items at $1. Dollar Tree sells house wares, toys, food, health and beauty aids, party goods and hardware.

Stronger demand from consumers looking to save money has created a great opportunity for Dollar Tree to open new stores and expand product offerings. During the first quarter, the company opened 83 stores, closed seven stores and expanded or relocated 41 stores.

Management’s efforts are paying off, evidenced by accelerating sales and earnings at a time when other retailers are suffering from declining sales. Dollar Tree’s balance sheet is strong with modest debt and plenty of cash to augment management’s aggressive expansion plans.

Dollar Tree reported excellent results for the quarter ended 4/30/11. Sales increased 14%, earnings per share (EPS) soared 67% and same store sales surged 7%. The company’s wider assortment of products, recent acquisitions and many new stores are meeting strong demand from consumers.

I expect sales to increase 11% and EPS to advance 16% during the next 12 months. At 15.1 times our forward 12-month EPS estimate of 4.15, DLTR shares sell at a very reasonable price. The company does not pay a dividend now, but dividends could be forthcoming within the next couple of years. DLTR shares are low risk.

operates 500 pawnshops plus 500 short-term consumer loan stores in the U.S., Mexico and Canada. The company provides convenient, short-term lending to customers, secured by their personal property including jewelry, electronics or other personal property. Pay-day loans are offered at high interest rates for very short periods of time.

Many banks are not lending to consumers in need of loans, and high unemployment is forcing many people to seek pawn loans. I expect banks to maintain tight lending conditions for another two years or more. High unemployment and under-employment also could linger into the foreseeable future.

EZPW is aggressively opening new stores and acquiring small businesses to meet demand and to gain market share in North America despite new regulations aimed at curbing exorbitant lending rates. EZCORP is complying with the strict new regulations and also is unveiling innovative services, while some of its competitors charge exorbitant lending rates. EZCORP’s above-board methods provide a competitive advantage.

The company’s sales rose 21% and EPS advanced 31% during the quarter ended 3/31/11, which was better than expected. Same-store revenue increased an impressive 12%. I forecast sales to increase 13% and earnings per share to rise 19% during the next 12-month period. Growth in the U.S., Canada and Mexico should increase at a solid pace, and the company’s expansion into Australia, the United Kingdom and Europe is producing better than expected results.

EZCORP’s balance sheet is very strong with minimal debt and plenty of cash to fund future expansion.  The company does not pay a dividend and may not for some time. EZPW’s shares are medium risk and offer excellent value at 11.3 times my forward 12-month EPS estimate of 2.75.

Until next time–be kind and friendly to everyone you meet.

Roy Ward
J. Royden Ward
Editor of Cabot Benjamin Graham Value Letter

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