A possibility of substantial gains

One of the interesting developments in the UK retail scene over the last decade has been the increasing popularity of discount stores such as Poundland (LSE: PLND). They have benefitted from an economic tailwind that has seen consumers shun purchases of brands in favour of cheaper and better value options.

Of course, this situation is perfectly understandable, since disposable incomes have fallen in real terms during the period. Now, though, wages are rising faster than inflation, and it could be argued that shops such as Poundland will become less popular, as consumers become less price-conscious and more interested in convenience and quality than they have been in recent years.

Despite this, Poundland is still forecast to increase its bottom line by 59% this year and by a further 22% next year. With its shares trading on a price to earnings growth (PEG) ratio of just 0.5 they seem to offer excellent value for money and the possibility of substantial capital gains. As such, they look set to beat the FTSE 100, even if interest in discount stores does begin to fade.

Top-notch growth prospect

Also having the potential to beat the FTSE 100 is Tesco (LSE: TSCO). It has been somewhat the opposite of Poundland in recent years because a shift to no-frills, cheaper supermarkets such as Aldi and Lidl has hurt Tesco’s top and bottom lines.

However, with the company’s new strategy of improving efficiencies and disposing of non-core assets repositioning Tesco for long term growth, it looks set to deliver improved financial performance in future.

With Tesco trading on a PEG ratio of 0.4, it appears to offer a very wide margin of safety. This means that it has an excellent chance of beating the FTSE 100, with its top-notch growth prospects not appearing to be fully priced in by investors. And with Tesco expected to increase dividends fourfold in the next financial year, there seems to be a clear catalyst to cause its shares to rise at a rapid rate in future.

With interest rates set to remain low, Tesco could gradually become a viable income play, with its value and growth potential already being high and more appealing than those of the wider index.

Forecast to fall

While Tesco and Poundland could beat the FTSE 100 over the medium to long term, funeral services provider Dignity (LSE: DTY) may underperform the wider index. That’s because it is forecast to post a fall in its bottom line of 3% in the current year and with its shares trading on a price to earnings (P/E) ratio of 22.7, they appear to be rather overvalued.

Certainly, Dignity has been a relatively sound defensive play in recent years and has been able to increase its earnings at a double-digit rate in each of the last five years.

But with the rest of a tough 2016 ahead, and a valuation that’s over 50% higher than that of the wider index, it is difficult to see a potential catalyst to push its shares higher. That’s especially the case since Dignity lacks income appeal, with a yield of just 0.9%.

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Peter Stephens owns shares of Tesco. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.