Michael Shulman

Money Does Grow on (Dollar) Trees

by Michael Shulman   08/22/08

When the threat of a recession or an economic slowdown starts hanging over Wall Street, the "R" word gets bandied about, often with tales of investors cashing out and heading for the hills.

But instead of feeling powerless to whatever the economy is or isn't going to do, buying put options is a terrific way to recession-proof your portfolio and let you make quick profits when spending slows down.

When consumer spending starts grinding to a halt, one sector that gets sucker-punched is the deep-discount retail group. That's right, your favorite "dollar" store can face some serious trouble when its regular customers are scaling back on their spending.

To make matters worse for the low-end retailers, their customers' connection to the housing recession also serves to hit them where it hurts -- that is, their bottom line.

Many of the poor and working poor -- the deep discounters' target consumers -- are employed by construction and contracting jobs. And with homebuilding drying up and inventories ballooning, even more layoffs are forthcoming.

Without paychecks, consumer spending at these stores will weaken, as people will have to decide between paying the electric bill and discretionary shopping at the lower-end retail establishments.

In October, one name looked like it was going to suffer most when people started missing mortgage payments when the first wave of adjustable-rate mortgages started resetting. And in the coming weeks, we made some very nice returns off of an investment that cost as much as an item at one of these stores.

One of the chains most vulnerable to this development was Dollar Tree (DLTR), which operates more than 3,300 stores across the United States under various names -- Dollar Tree, Deal$, Dollar Bills and Dollar Express.

It had the most exposure to a general downturn and also had significant exposure in Sunbelt states and California, where homebuilding -- and workers in the industry -- had been hit particularly hard.

At the time, Dollar Tree was forecasting fourth-quarter earnings that would miss expectations, and the company anticipated that sales for stores open at least a year would be flat for the holiday quarter.

My research told me that their ho-hum outlook was generous, considering that the company had to pull 300,000 toys off of its shelves thanks to the fiasco over Chinese-made toys containing lead paint.

Back on Oct. 11, Dollar Tree shares hit a high of $42.75, but with a lousy holiday forecast looming, we got into the DLTR Feb 35 Puts when premiums were low and before Wall Street wised up and saw the slide coming, too.

Talk about a low-cost investment that was better than anything we could buy in the Dollar Tree -- we bought the puts for $1.05 on Oct. 11 and celebrated when we cashed them out on Oct. 22 for a 138% gain.

But Dollar Tree wasn't done giving yet.