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Dollar Tree: Consider Shorting This Overvalued Stock

February 15, 2012 | About:
Dollar Tree (DLTR) is a major discount variety store company operating in the U.S. and Canada. Increasingly, Dollar Tree looks to have all the elements of a short opportunity. In the following article, I will discuss the reasons why I believe investors should consider shorting this stock.

A more positive jobs outlook and faster economic recovery will mean that consumers will put their discretionary income into better products than those offered by Dollar Tree. I have long considered Dollar Tree to be a value stock; however, in light of the recent economic boost, I believe investors are now better off looking at Walmart (WMT) and Target (TGT). I think consumers will make more basic purchases at places they already shop, rather than making an extra stop on the way home to purchase those really cheap household necessities such as paper towels, laundry detergent and other products. Additionally, I found that all but one of the metrics agree that the economy is lining up in such a way which suggests that the company’s results will suffer as people trade up to better quality products with an increase in incomes.

In looking at the numbers data, Dollar Tree's trailing five-year valuation metrics suggest that the stock is overvalued as all three of the metrics are above their respective five-year averages. Dollar Tree's current P/B ratio is 6.96 and it has averaged 3.87 over the past five years with a high of 7.17 and low of 2.61. Dollar Tree's current P/S ratio is 1.57 and it has averaged 0.96 over the past five years with a high of 1.62 and low of 0.61. Dollar Tree's current P/E ratio is 22.65 and it has averaged 17.13 over the past five years with a high of 22.78 and low of 13.4.

The forward valuation metrics comes to the same conclusion. Dollar Tree is currently trading at about $85 a share with analysts expecting EPS of $4.76 next year, an earnings increase of 18% year over year, for a forward P/E ratio of 17.8. Taking a look at the company's competitors will give us a better idea of the stock's relative valuation. Dollar General (DG) is currently trading at about $42 a share with analysts expecting EPS of $2.7 next year, an earnings increase of 16%, for a forward P/E ratio of 15.7. Family Dollar (FDO) is currently trading at about $56 a share with analysts expecting EPS of $4.17 next year, an earnings increase of 15%, for a forward P/E ratio of 13.4. Big Lots (BIG) is currently trading at about $40 a share with analysts expecting EPS of $3.36 next year, an earnings increase of 17%, for a forward P/E ratio of 11.8. The mean forward P/E of Dollar Tree's competitors is 13.6 which suggests that Dollar Tree is overvalued relative to its publicly traded competitors.

The consensus price target for the analysts who follow Dollar Tree is $86. That is upside of just 2% from today’s stock price and suggests that the stock is overvalued at these levels. This also suggests that the stock has limited upside and should be avoided.

The last metric is the only one that differs in its opinion. According to the cash flow metric provided by Dividend Kings, Dollar Tree is worth $95 a share versus its current stock price of $84.96 a share. This suggests that the stock is fairly valued.

The top two funds that own Dollar Tree are Fidelity Contrafund, which owns 8.7 million shares or 7.29% of the shares outstanding, and Fidelity Low-Priced Stock, which owns 2.2 million shares or 1.85% of the shares outstanding. The top two institutions that own Dollar Tree are Fidelity Management and Research Company, which owns 17.3 million shares or 14.19% of the shares outstanding, and Vanguard Group Inc., which owns 6.7 million shares or 5.66% of the shares outstanding.

Looking at the chart, the stock has been strong all year as it is up 62.8% over the past year, outperforming the S&P 500 which is up 5%. Looking at the technicals, the stock is currently above its 50 day moving average, which sits at $83.29 and above its 200 day moving average, which sits at $76.18.

I believe this stock presents a short opportunity right now. I expect Dollar Tree to see a decrease in sales and revenue growth in the coming quarters. I strongly believe news of an even slightly faster economic recovery will create significant headwinds for this stock. As consumers begin to gain confidence in the job market and discretionary income increases, they will put their dollars into higher quality goods.

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