Dollar store chain Dollarama (TSX:DOL) has been a top growth stock to own on the TSX for years. The stock has soared around 280% over the past five years, nearly quadrupling in value. Today, its market cap sits at roughly $54 billion. However, as of Jan. 16, the stock has declined by 4% to start the new year. Could this be the start of more of a decline, or is Dollarama a good buy on this recent weakness?
The dollar store chain is generating solid growth and in its most recent earnings it reported comparable sales growth of 6%, benefiting from an increase in average transaction volume and size. It's been doing fairly well despite economic challenges and consumers tightening up their budgets.
There's no doubt the business is still solid. But the problem may be its valuation.
Dollarama's stock is trading at 42 times its trailing earnings. For that kind of a multiple, investors should expect strong growth, and perhaps an even better growth rate than what Dollarama has already been achieving. It creates high expectations which may not be easy to meet, even if the business has a strong quarter.
That's why despite its weakness to start the year, I wouldn't suggest rushing out to buy Dollarama's stock today. It's highly valued and the premium looks excessive. As investors consider valuations, the stock may decline lower in the weeks and months ahead. For now, I'd take a wait-and-see approach with it as its excessive premium may result in an even further decline in the near future.
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