3 Reasons Why Dollarama Inc. (TSX:DOL) Is Pressured

Should you buy Dollarama Inc. (TSX:DOL) now that its stock is down?

| More on:

Dollarama (TSX:DOL) stock has fallen meaningfully by about 15% since reporting its third-quarter results last week. Taking a step back, in the last 12 months the stock has corrected about 38%.

Looking at an even bigger picture, despite the huge drop in the stock, a stock investment in Dollarama has actually returned about 18% per year in the last five years. In the period, the growth stock’s price-to-earnings ratio (P/E) contracted from about 25 to under 20, but the strong growth in the company still led to outsized returns.

Why Dollarama is pressured

As Fool contributor David Jagielski discussed in his recent article on Dollarama, the stock continued to be depressed after reporting its third quarter results because the company’s growth has been tapering off.

Additionally, Dollarama’s debt levels have been on the rise. For example, its debt-to-assets ratio is at its all-time high.

DOL Debt to Assets (Quarterly) Chart

DOL Debt to Assets (Quarterly) data by YCharts. Change in Dollarama’s debt-to-assets ratio over time.

Having high debt levels means there will be little wiggle room for the company to borrow to boost growth. If anything, it’ll be healthier for the company to consider reducing its debt levels as interest rates (and as a result, borrowing costs) increase.

In the first nine months of the fiscal year, Dollarama sourced 56% of its purchases overseas. While Dollarama buys products from more than 25 countries, the majority of its overseas products come from China, for which it pays in U.S. dollars. So, foreign exchange fluctuations between the currencies that Dollarama deals with will change its cost of sales. In the period, Dollarama’s sales increased by 6.9%, but its cost of sales increased by 7.6%.

Watch stock valuations

It’s important to note that when Dollarama traded at the peak of about $56 per share in January, it traded at a P/E of almost 37. Stocks usually don’t stay at such a high multiple for long because high growth that supports high valuations don’t last for long.

Dollarama’s five-year normal P/E is about 24.7. So, it’s a good starting point to research and consider Dollarama when it trades at a P/E of 24.7 or lower. Currently, at under $32 per share as of writing, Dollarama trades at a P/E of about 19.1, while analysts estimate the growth company will grow its earnings per share by about 12.7% per year on average over the next three to five years. So, the stock trades at a reasonable PEG ratio of about 1.5.

Investor takeaway

Dollarama is a well-run company and enjoys higher margins than its U.S. peers with a recent net margin of about 15.7% compared to the U.S. peers’ roughly 7-7.6%. However, the stock is in a downward trend. Despite the stock now being oversold at current levels, interested investors should watch for consolidation in stock or buying action from the market for a safer entry point.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Kay Ng has no position in any of the stocks mentioned.

More on Dividend Stocks

Silver coins fall into a piggy bank.
Dividend Stocks

Here’s the Average RRSP Balance at 45 in Canada

The RRSP is a strong tool for investors, but only if you invest in top stocks like this ETF for…

Read more »

Start line on the highway
Dividend Stocks

Retirement Planning: Dividends vs. Growth (Or How About Both?)

Building a healthy mix of income and growth potential in your retirement portfolio is essential. Even if you can't access…

Read more »

Canadian Dollars bills
Dividend Stocks

This 5.44% Dividend Stock Pays You Cash Every Month

Here's a high-yield REIT is ideal for portfolio diversification, not to mention the monthly cash flow streams for income-focused investors.

Read more »

ETF stands for Exchange Traded Fund
Dividend Stocks

2 High-Yield Dividend ETFs to Buy to Generate Passive Income

Both of these ETFs boast double-digit yields and pay on a monthly basis.

Read more »

space ship model takes off
Dividend Stocks

Passive Income: How to Invest Your TFSA Limit in 2025

TFSA income investors still have good options heading into 2025.

Read more »

people relax on mountain ledge
Dividend Stocks

2 Reasons to Buy Gildan Activewear Stock Like There’s No Tomorrow

Here are two main reasons why Gildan Activewear stock could be a great buy now, especially for long-term investors.

Read more »

data center server racks glow with light
Dividend Stocks

Billionaires Are Selling NVIDIA and Picking Up This TSX Stock

Brookfield Corp (TSX:BN) is seeing increased buying by billionaires, while NVIDIA (NASDAQ:NVDA) is seeing increased selling.

Read more »

Canadian dollars in a magnifying glass
Dividend Stocks

2 Must-Watch Dividend Stocks for December

Consider Quebecor (TSX:QBR.B) and another intriguing dividend stock to buy on weakness for December.

Read more »