Shares of Dollar Tree Inc. (DLTR, Financial) gained more than 12% on Tuesday. The Chesapeake, Virginia-based discount retailer reported third-quarter results before the market opened, beating analysts' expectations for both revenue and earnings.
Shares are now trading just 2% off their 52-week high, which leaves little room to run. At the current price-earnings ratio of 29.42, the stock looks overvalued based on the Peter Lynch earnings line.
Dollar Tree posted significant gains in revenue and earnings while same-store sales also improved. The company did not issue guidance for the fourth quarter and full year amid the uncertainty created by the coronavirus pandemic.
Highlights from the recent quarterly results
Dollar Tree's earnings per share grew 28.7% from the prior-year quarter to $1.59— beating the consensus Street estimate of $1.15. Revenue surged 7.5% to $6.177 billion, which again outperformed the market estimate of $6.12 billion. Enterprise same-store sales soared 5.1% year over year, adding to the company's strong quarterly performance.
Dollar Tree ended the quarter with $1.118 billion in cash and cash equivalents despite paying $500 million on a revolving credit facility. It plans to spend another $300 million to service a Family Dollar note that is due in February.
The company is focusing on improving its operational efficiency, which will result in more free cash flow. In the third quarter, its operating margin increased 50 basis points on the back of Family Dollar's growth of 250 basis points.
Valuation
From a valuation perspective, shares of Dollar Tree appear relatively expensive when compared to close peers. The company's trailing price-earnings ratio of 29.42 is significantly higher than Dollar General Corp.'s (DG, Financial) equivalent of 23.20 and Target Corp.'s (TGT, Financial) 23.64.
However, when we look at projected earnings growth, Dollar Tree's forward price-earnings ratio of 15.70 is more compelling than Dollar General's 22.22 and Target's 20.62. Its PEG ratio, which factors in earnings growth for the next five years, of 1.49 also trumps Dollar General's 1.62 and Target's equivalent of 2.12.
Conclusion
Shares of Dollar Tree appear to be relatively overvalued based on earnings from the trailing 12-month period. The Peter Lynch earnings line also supports this view. However, when we factor in projected earnings for the next 12 months and beyond, the company's stock looks relatively undervalued compared to peers.
Nonetheless, given the unpredictable nature of the market amid the coronavirus pandemic, it would be good to be cautious when considering a stock on the basis of projected earnings.
Disclosure: No positions in the stocks mentioned.
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