Rise of Discount Retailers: Capitalizing on Undervalued Stocks in a High-Inflation Market

The retail landscape is shifting dramatically as consumers prioritize affordability and necessity amid persistent inflation. Discount retailers like Walmart (WMT), Dollar General (DG), and Dollar Tree (DLTR) are emerging as winners, while traditional department stores such as Macy's (M) and Kohl's (KSS) struggle to adapt. This article examines the factors driving this divide, highlights undervalued opportunities, and offers actionable investment strategies.

The Performance Gap: Discount Retailers Outperforming in Inflationary Environments

Recent stock performance underscores the stark contrast between discount and traditional retailers:

• Walmart (WMT): YTD 2025 return of +8%, driven by its 60% grocery sales mix, which insulates it from discretionary spending declines. Its first-quarter U.S. same-store sales rose 4.5%, outpacing estimates.
• Dollar General (DG): Surged +49.5% YTD, benefiting from a "Back to Basics" turnaround plan, including store remodels and cost cuts. Despite thin margins (near 10-year lows), investor optimism has lifted its valuation.
• Macy's (M) and Kohl's (KSS): Both declined sharply (-31% and -38% YTD, respectively), reflecting weak demand for discretionary items like apparel and home decor.

Key Metrics: Why Discount Retailers Are Winning

1. Revenue Stability

Discount retailers dominate essential categories:
- Walmart's grocery sales and everyday low pricing strategy ensure consistent traffic.
- Dollar General's focus on rural markets and basics (e.g., food, household goods) aligns with inflation-hit consumers.

2. Margin Resilience

• Walmart's gross margin remains robust at 24.2%, supported by economies of scale.
• Dollar General's margins, while compressed, are stabilizing after operational improvements.
• Traditional retailers like Macy's face margin erosion due to reliance on discretionary spending and higher inventory costs.

3. Valuation and Dividends

• Walmart: Traded at a forward P/E of 37, elevated compared to historical averages. Its 0.9% dividend yield is modest.
• Dollar General: P/E under 20, offering better value. A 2.3% dividend yield attracts income investors.
• Macy's and Kohl's: Both trade at depressed valuations but lack clear paths to profitability (e.g., Macy's 0.8% net margin, Kohl's -0.5% net margin).

Why Discount Retailers Are Here to Stay

Consumer Shift to Essentials

Inflation has reshaped spending:
- Essentials vs. Discretionary: Grocery and staple spending rose 12% in 2024, while apparel sales fell 5%.
- Discount retailers cater to this shift, while department stores suffer from declining foot traffic.

Operational Flexibility

• Walmart: Leverages global scale, e-commerce growth (22% sales rise in Q1 2026), and advertising revenue (50% growth).
• Dollar General: Aggressively divesting non-core assets (e.g., Family Dollar sale) to refocus on core markets.

Valuation Sweet Spots

• Dollar General and Dollar Tree trade at sub-20x forward P/E, far below Walmart's premium multiple. Their recovery trajectories make them compelling turnaround plays.

Investment Strategies: Capturing Growth and Value

1. Focus on Turnaround Plays

• Dollar General (DG): Buy for its undervalued stock and operational improvements.
• Dollar Tree (DLTR): Up +25.2% YTD, but still offers upside if cost cuts and store closures stabilize margins.

2. Consider Defensive Plays

• Walmart (WMT): A stable, if overvalued, option for portfolios needing retail exposure. Avoid chasing its stock; wait for a pullback.

3. Avoid Overleveraged Losers

• Macy's (M) and Kohl's (KSS): Their high dividend yields (e.g., Kohl's 14.8%) may attract yield seekers, but structural challenges (e.g., weak margins, high debt) make them risky bets.

4. Monitor Margin Health

• Track Walmart's advertising revenue growth and Dollar General's gross margin trends as key indicators of sustainability.

Conclusion: Position for a Retail Revolution

The rise of discount retailers is a structural shift, not a temporary trend. Investors should prioritize stocks with exposure to essentials, strong cost controls, and undemanding valuations. While Walmart's dominance is undeniable, its premium price tag leaves room for Dollar General and Dollar Tree to outperform.

Actionable Takeaway:
- Allocate 50% to DG for its valuation upside and 50% to DLTR for its recovery potential.
- Avoid Macy's and Kohl's unless they demonstrate margin improvements or strategic pivots.

The discount retail sector offers a rare combination of growth and value—capitalizing on it could be a winning strategy in 2025 and beyond.