Famed billionaire Seth Klarman is a student of the father of value investing Benjamin Graham. His iconic book Margin of Safety, available on Amazon for only $1,800, lays out his principles for buying stocks. 

He believes in a bottom-up, fundamental style of analysis that focuses on risk before returns. Klarman argues investors should be more concerned about potential losses than gains as preserving capital is essential. To do so, only stocks trading at a deeply discounted price relative to its intrinsic value, which he calls a margin of safety, should be bought.

That view has served Klarman well during his tenure at his Baupost Group hedge fund. He has generated an impressive average annual return of 20% over the past 30 years and a 15% return for the past four decades.

Despite the stock market being at all-time highs, he has found a number of stocks to buy that fit his models. In his 13-F with the Securities & Exchange Commission for the third quarter, Klarman started new positions in five different companies, though four of them were de minimis positions that account for less than 0.50% of his $3.5 billion portfolio.

One stock, though, he went deep on, acquiring over 2.3 million shares valued at almost $195 million to represent a 5.6% position in Baupost: dollar store giant Dollar General (NYSE:DG). It is now his seventh largest holding out of 20 stocks.

24/7 Wall St. Insights:

• Enigmatic billionaire investor Seth Klarman is a deep value investor in the vein of Benjamin Graham.
• He likes buying stocks offering a deep discount to their intrinsic value.
• Klarman’s Baupost Group hedge fund bought several stocks last quarter, but only bought big on one.
• If you’re looking for some stocks with huge potential, make sure to grab a free copy of our brand-new “The Next NVIDIA” report. It features a software stock we’re confident has 10X potential.

Poor performance in a prime environment

The deep discount retailer is itself trading at a deep discount to where it previously was. Dollar General stock is down 46% in 2024, and is 72% below its all-time high reached back in 2022. You have to go back seven years to find the last time the dollar store chain traded at these prices.

Price is only part of the story. DG stock goes for just 12 times trailing earnings and estimates, a small fraction of its sales, and a bargain-basement 9 times the free cash flow it generates. Since going public in 2009, Dollar General has never traded at such low valuations. 

The economy is in an environment that should be ripe for dollar stores like Dollar General and rival Dollar Tree (NASDAQ:DLTR), yet both have been beaten down. After the recent inflationary period that saw consumers flock to their stores to stretch their wallets and get more bang for their buck, both chains have fallen hard. In the last three years, Dollar General lost two thirds of its value while Dollar Tree was cut in half.

Dollar General’s third-quarter financials were a mixed bag, beating on the top line, but falling short on profits as the chain was hit by hurricane-related charges. Net sales rose 5% to $10.2 billion, just beating estimates of $10.1 billion, as same-store sales rose 1.3%, but net income of $196.5 million, or $0.89 a share, was down from $276.2 million, or $1.26 a share, in the year-ago period. Wall Street had expected earnings per share of $0.94.

Why did Klarman buy Dollar General stock?

Certainly the metrics are part of the reason a value investor like Klarman is intrigued by Dollar General. Because it operates over 20,500 stores across banners including Dollar General, DG Market, DGX, and Popshelf, as well as Mi Súper Dollar General stores in Mexico, its network of stores give it a strong market presence that still resonates with low- and middle-income consumers. The retailer’s entry into Mexico also hints at potential opportunity for further expansion.

There are hurdles too. Its consumers are the ones hurt most by inflation, limiting their ability to spend more. The retailer also has limited e-commerce operations, which is an increasingly important channel when trying to reach consumers.

Yet with a focus on small-town locations targeting their demographic, an expanding product lineup, and fairly efficient operations, Dollar General stock can still drive long-term growth and shareholder value.

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