Why This Discount Retailer Could Jump 28%

The retail sector has today's investors stumped...

You've got Walmart hitting new all-time highs... Target hitting multiyear lows... and department-store stocks like Macy's falling, but not quite crashing.

It's hard to make heads or tails of it all. But it has been nothing but bad news for one part of the sector: the "dollar store" retailers.

The two main players in this market have crashed. However, one of them has fallen too far, too fast. And that's setting this stock up for a 28% rally, according to history.

Let me explain...

With more than 16,000 stores in the U.S., Dollar Tree (DLTR) is the second-largest dollar-store chain in the U.S.

The discount retailer sells everything from food to party supplies to home goods. And of course, it aims to deliver incredibly low prices.

That business model has served Dollar Tree well. The company went public nearly three decades ago... And it has roughly doubled the annual return of the S&P 500 Index since then.

The stock has hit hard times in recent months, though. It's down more than 30% since the end of July. And that decline has pushed shares to an important level.

Specifically, the stock hit "oversold" territory based on the relative strength index ("RSI"). The RSI is a simple indicator... It uses recent prices to determine if a stock has gone too far, too fast in either direction.

It's one of our favorite tools in contrarian investing. That's because it signals when a reversal is likely. When a stock rises too much and hits "overbought" territory, it's due for a pullback in prices... And when a stock drops to oversold levels, a snapback rally tends to follow.

In the case of Dollar Tree, its price and RSI have both plunged recently. Take a look...

Typically, any RSI lower than 30 is an "oversold" reading. For Dollar Tree, the RSI hit that level – and then some. Its initial signal rapidly dropped below 20... And the recent low was 16.5!

That's a serious fall. I wanted to see what similar setups had led to in the past. So, I looked at each instance of the RSI falling below and then rising back above 20.

That has happened only six other times since the turn of the century. And the returns that followed were fantastic. Take a look...

Discount retail has been a solid business this century. Dollar Tree's stock has returned more than 10% a year over the past 23 years. But if you buy after it's deeply oversold, you can crush that return.

Similar setups led to 18.9% gains in three months, 13.2% gains in six months, and 27.7% gains over the next year. That's nearly triple the annual gain from just buying and holding.

Even more, the stock was up a year later in five of those six instances. And the biggest winning trade led to more than 100% gains in just a year.

It's always tough to buy a stock after it has crashed. And importantly, the retailer's RSI hasn't moved back above 20 yet.

You should always wait for the uptrend to return before you consider buying. But Dollar Tree's recent weakness is too much. History shows this decline is likely just a phase.

In other words, this discount retailer isn't dead just yet... And that means investors could see big gains in the months ahead.

Good investing,

Brett Eversole

Further Reading

Dollar Tree's stock is poised to rally. But we're still seeing challenges ahead for the broader retail sector – and for many U.S. consumers. Recent earnings from retailers shows that instead of spending on big-ticket items, most shoppers are hitting the bargain bin... Get the full story here.

After a huge rally, the stock market has hit a wall. This is a rare setup – but based on history, it means outperformance is likely. Not only that, but this signal has a perfect track record of pointing to higher stock prices a year from now... Read more here.