Why Did Dollar Tree Stock Drop 21% in August?

What happened

Shares of Dollar Tree (DLTR -0.46%) fell 20.5% last month, according to S&P Global Market Intelligence. The company beat Wall Street’s estimates for both revenue and earnings, but investors were worried about the discount retailer’s commentary on consumer behavior moving forward.

So what

Dollar Tree reported a respectable 7% growth in same-store sales, a metric that controls for store openings and closures to provide a more clear picture of location-level performance. Its overall sales growth rate was even higher, and it topped consensus analyst estimates. Dollar Tree also performed well in terms of profits, with earnings per share (EPS) of $0.91 that was four cents higher than expected.

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However, investors ignored those modest wins and were fixated on other portions of the earnings report that could be signs of tougher times to come. The company’s gross margin declined thanks to sales mix and shrink. Buying trends show that people are favoring essentials as they feel pressure from inflation and a slowing economy, and these tend to be lower margins for Dollar Tree. Shrink generally refers to theft or inventory damages, and it can be a leading indicator of economic hardship. Theft has become a big enough issue that Dollar Tree is taking strategic action, and that’s likely to incur some sort of cost.

For a narrow margin business like Dollar Tree, relatively minor disturbances to sales or gross profit can have significant effects on the bottom line. This makes stock prices extra sensitive to those fluctuations, and concerns about theft or consumer health can cause steep sell-offs like the one in August.

It was a bad month overall for retailers, with investors growing more concerned about the state of the consumer. High interest rates, swelling consumer debt, inflation, and a cooling job market are all potential headwinds for retail stocks right now. The SPDR S&P Retail ETF (XRT -0.53%) is down more than 8% since the start of August as a result.

XRT Chart

XRT data by YCharts

Now what

Dollar Tree is in decent shape to ride out a potential economic downturn. People tend to seek cheaper deals when times are tight, and discount retailers that sell staples are often the beneficiaries. The stock’s modest valuation ratios, including a forward price-to-earnings ratio below 20 and enterprise-value-to-EBITDA ratio below 15, also remove some risk. This stock is unlikely to be as volatile as higher growth stocks with more aggressive valuation ratios.

However, it does seem likely that margin pressures will continue. None of the trends that have affected Dollar Tree’s profitability will go away any time soon. Investors should also be aware that Dollar Tree stock doesn’t pay a dividend, unlike many of its value stock peers. There’s nothing inherently wrong with that fact. However, a dividend is an attractive feature for many investors. Yield tends to create more demand and reduce volatility, so Dollar Tree might lack that support, unlike many of its defensive peers in the consumer staples sector.

Ryan Downie has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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