TJX Companies Inc. (TJX, Financial) has historically delivered solid returns for shareholders. The stock has delivered a total return of roughly 68% over the past three years, while the S&P 500 has delivered a total return of roughly 26% over the same period. The move higher has been driven by strong earnings growth and investor enthusiasm for the company's international expansion plans.

Currently, the stock trades at roughly 27 times forward earnings per share, which represents a significant premium to the broader market, a premium to other discount retailers and a valuation which is in line with some of the highest-quality businesses in the world. While it may be able to maintain current levels, I view significant upside as limited due to the stock's high valuation.

Company overview

TJX Companies is a leading discount retailer with over 4,900 locations across nine countries. The company operates stores under a number of different brand, names including TJ Maxx, Marshalls, Sierra, HomeGoods, Winners and others. While the company generates most of its sales in the U.S., international markets include Canada, Australia, Germany, the U.K., Austria, Poland, the Netherlands and Ireland.

The company generally offers a rapidly changing assortment of merchandise at prices 20% to 60% below full-price retailers. The company is able to achieve these prices by deploying an opportunistic buying merchandising strategy that allows it to acquire goods at lower prices than other retailers. TJX Companies embraces the fact its merchandise tends to change frequently and offers consumers a treasure hunt-type shopping experience. Despite operating in a highly competitive industry, the company has been able to generate solid results and has generated a return on capital well above its cost of capital.

Retail is a tough business, but TJX is well positioned

While TJX Companies has been able to deliver strong results historically, the fact remains the company operates in a very difficult industry. The retail business is highly competitive and the company faces competition from other physical and online retailers. Key competitors include Walmart (WMT, Financial), Target (TGT, Financial), Ross Stores (ROST, Financial), JC Penney (JCPNQ, Financial), Kohl's (KSS, Financial), Amazon (AMZN, Financial) and many others. In addition to being highly competitive, the retail business is fairly capital intensive due to the need for retailers to hold inventory. Finally, the retail business is also challenging because consumer tastes and preferences rapidly evolve.

Investing guru Warren Buffett (Trades, Portfolio) summed up the challenges that retailers face in his 1995 shareholder letter:

"Retailing is a tough business. During my investment career, I have watched a large number of retailers enjoy terrific growth and superb returns on equity for a period, and then suddenly nosedive, often all the way into bankruptcy. This shooting-star phenomenon is far more common in retailing than it is in manufacturing or service businesses. In part, this is because a retailer must stay smart, day after day. Your competitor is always copying and then topping whatever you do. Shoppers are meanwhile beckoned in every conceivable way to try a stream of new merchants. In retailing, to coast is to fail."

As a result of these factors, a number of leading U.S.-based retailers have gone out of business despite having a very strong market position for long periods of time. Notable retail failures include Sears, Lord & Taylor, Bed Bath & Beyond, Toys R Us, Circuit City and many others.

TJX Companies is well positioned in that, thus far, it has been mostly immune to the threat posed by Amazon and other online retailers. Consumers continue to value the treasure hunt shopping experience and TJX's prices tend to be very competitive with Amazon. On the company's most recent earnings call, CEO Ernie Herman responded to a question regarding new competition from Temu and Shien:

"On the question about some of those online players you were talking about, we feel just as similar -- they're so commodity-driven and so not the brands that we would carry very much not the good, better, best type of branded mix that we would go after. We see very little issue with them taking market share from us. I could see that their business model could overlap with some other brick-and-mortar guys or some other online guys for sure. But we just don't see that as bumping up with our customer base or end use."

Valuation comparisons

Currently, TJX Companies trades at roughly 27 times forward earnings per share. Comparably, the S&P 500 trades at around 22 times forward earnings per share. Thus, the company is currently trading at a significant premium to the broader market. Moreover, it is trading at a valuation which is fairly close to some of the highest-quality stocks in the market, such as Apple (AAPL, Financial) and Microsoft (MSFT, Financial), which trade at 29 and 31 times forward earnings.

While Apple and Microsoft represent vastly different businesses than TJX Companies, they represent a valuable yardstick as to what a reasonable valuation is for a very high-quality business. Given the fact the company competes in a highly competitive business, I believe there is a solid case to be made that it should trade at a significant discount to these stalwarts.

Consensus estimates currently call for TJX Companies to report earnings per share growth rates of 7% for fiscal year 2025, 10% for 2026 and 13% for 2027. Comparably, the S&P 500 is expected to deliver earnings growth of roughly 11% for 2024 and 14% for 2025. Thus, on a relative basis, TJX Companies' valuation premium does not appear to be warranted versus the broader market based on earnings growth prospects.

In addition to trading at a premium to the broader market, TJX Companies is also trading at a premium relative to its peers. Ross Stores, which is arguably its closest competitor, trades at 23 times forward earnings per share and has near-term growth prospects that are similar to TJX. Burlington Stores (BURL, Financial), another comparable discount retailer, trades around 32 times forward earnings, but is expected to experience faster near-term earnings growth. Consensus estimates call for Burlington Stores to report annual earnings per share growth of roughly 27%, 23% and 23% over the next three years. Walmart, which is somewhat different due to its larger scale, focus on grocery and strong online retail presence, trades at 28 times forward earnings.

Another reasonable comparison is dollar stores given their focus on discount retail. Dollar General (DG, Financial) and Dollar Tree (DLTR, Financial) trade at 16.50 and 14.30 times forward earnings. While Dollar General has near-term growth prospects which are similar to TJX Companies, Dollar Tree has arguably better growth prospects and is expected to grow earnings per share by 12.70%, 18.50% and 13.90% over the next three years.

TJX Companies is also trading at a premium to its own historical median valuation based on key metrics such as forward price-earnings ratio. Historically, the stock has traded at a median price-earnings ratio of 22. Taken together, I view the stock's valuation re-rating potential as more skewed toward the downside as a reasonable case can be made that the stock should trade closer to 23 times forward earnings, which would put it more in line with its closest peer. Using dollar store stock valuations as a guidepost would suggest TJX Companies could trade at a mid-teens multiple. On the other hand, I do not see much of a case for the stock to trade at even a modestly higher valuation than is currently the case as that would put the stock's valuation at a premium to Walmart and in-line with technology stalwarts Apple and Microsoft.

How TJX could grow into its current valuation

While TJX Companies is currently trading at a high valuation, the stock could return to more reasonable levels if it is able to deliver better-than-expected earnings growth over the next few years. The company has ambitious plans and believes it can grow its total store count to more than 6,200 locations over the long term. Moreover, the company has potential to gain market share from other brick-and-mortar retailers which are closing stores. Macy's (M, Financial) has announced plans to close 150 stores over the next few years and it would not be surprising to see other department stores follow suit.

Expansion into new international markets also has potential to be a major growth driver. In early June, TJX Companies announced plans to form a joint venture with Grupo Axo. As part of the proposed transaction, which is expected to close later this year, TJX Companies would become a 49% owner of Axo's existing off-price business in Mexico, which includes more than 200 stores.

Additional merger and acquisition opportunities could provide another lever for the company to deliver better-than-expected earnings growth. TJX Companies is not a stranger to large-scale deals and acquired one of its largest brands, Marshalls, in 1995. At the time, Marshalls was the second-largest off-price retailer in the U.S. TJX Companies also acquired Winners in 1990.

Perhaps the most exciting M&A opportunity for TJX Companies currently would be to acquire its leading competitor, Ross, which has a market capitalization of $47 billion compared to its market cap of $130 billion. The Ross Stores brand could complement TJX Companies' existing brands well as it tends to focus on the low end of the off-price retail business, while TJX Companies tends to focus more on the middle market. Moreover, a merger with Ross Stores could give TJX better bargaining power with suppliers and create back-end cost synergies that could help improve margins, resulting in better-than-expected earnings growth.

Conclusion

TJX Companies has a solid history of delivering strong results for shareholders despite operating in a very challenging industry. The company has provided customers with a unique value proposition, which includes a treasure hunt shopping experience. Unlike many other traditional retailers, TJX has continued to grow despite the secular shift toward online operations.

The stock currently trades at a significant premium to the broader market and has lower near-term growth prospects. Additionally, the stock trades at a significant premium to its closest competitor. While the company may be able to grow into its current valuation by delivering better-than-expected earnings growth, I believe upside for the stock from current levels is limited due to its high valuation.