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Will the Bulls Continue to Run?

After posting fantastic earnings last week, shares of Dollarama Inc. (TSX:DOL) reached a 52-week high on the optimism of further growth and higher profits.

As investors, we continually seek opportunities to acquire an asset with earnings power that will grow and improve over time. The question, “What am I giving (paying) and what am I getting?” is always one of the most important question investors can ask themselves when purchasing shares in any company.

In the case of Dollarama, investors are aware of the company’s ability to grow revenues and earnings. With enough earnings growth, dividends will eventually follow suit and investors will be rewarded. The challenge investors face is the price that has to be paid to purchase shares of the company.

Currently offering investors a dividend yield of 0.4%, the company trades at approximately 30 times earnings. Although earnings are growing impressively, they have to grow at such a high rate to justify the current stock price. Investors may want to think twice about purchasing shares in this security.

In past fiscal years, earnings have been $1.74 (2014), $2.21 (2015), $3 (2016), and $3.71 (2017), an annual increase of 28%. Although this is very impressive, the growth in earnings is not sustainable over the long term.

The annual growth of earnings of 28% has happened while the growth in revenues has been only 12.8%. Revenues were $2,064 million (2014), $2,330 million (2015), $2,650 million (2016), and $2,963 million (2017). While the opportunities to reach better economies of scale have gone a long way to the bottom line already, the company can only squeeze so much before consumers demand better quality.

While Dollarama plans to expand and open more stores, the company’s dominant position has not gone unnoticed. Many dollar store chains south of the border may now be looking at making inroads into Canada as Dollarama continues to deliver and see its share price reach new 52-week highs regularly.

Everything seems to be going in the right direction for the company, as past expansion has been done successfully, and another round of new stores are in the pipeline. While Dollarama is in an excellent position to capitalize on the closing of many of Canada’s major retailers, the retail landscape is changing, and the company’s position is not guaranteed.

Currently, Dollarama is the new anchor tenant in many smaller strip malls. The company may need to be very careful as plans to open more locations are rolled out. As investors have learned from massive retailers south of the border, sometimes too much of a good thing becomes a bad thing. This shift in retail may lead to eventual store closings.

In the case of Dollarama, investors should be cognizant about paying for opportunity rather than buying into something which is an established value opportunity. Buyer, beware.

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