Shares of Dollar Tree (NASDAQ:DLTR) plunged 14% on March 7, after the company's fourth quarter numbers missed estimates on the top and bottom lines. But even after that drop, the stock remains up 16% over the past 12 months, compared to the S&P 500's 14% gain.

Dollar Tree's Q4 numbers initially looked solid. Its revenue rose 13% annually to $6.36 billion, marking its strongest growth in six quarters. Its adjusted earnings climbed 42% to $1.89 per share. However, those figures missed Wall Street's revenue estimate by $30 million and its earnings estimate by a penny.

A businessman waters a tree with leaves made of dollar bills.

Image source: Getty Images.

Is this a case of bullish analysts setting the bar too high for a solid company, or is something actually wrong with Dollar Tree? Let's dig deeper to see if the big sell-off represents a good buying opportunity.

When "good" isn't good enough

Dollar Tree's systemwide "enterprise" comps rose just 2.4% during the quarter. That missed the analyst estimate of 2.7% and marked a slowdown from its 3.2% growth in the previous quarter.

Dollar Tree's namesake stores posted 3.8% comps growth on a constant currency basis, while its Family Dollar stores -- which were acquired in 2015 -- reported just 1% growth. Those figures compared poorly to Dollar Tree's 5% growth and Family Dollar's 1.5% growth during the third quarter.

Dollar Tree sells all of its products for $1 or less, while Family Dollar sells its goods for $10 or less. The big gap between Dollar Tree and Family Dollar's comps indicates that the former still holds a defensible niche, while the latter remains vulnerable to bigger discount retailers like Walmart (NYSE:WMT).

For 2018, Dollar Tree expects 2%-4% sales growth, based on a "low single-digit" increase in comparable store sales. That top line guidance matched analyst estimates, but its bottom line guidance -- for 8%-15% growth in adjusted earnings -- missed expectations for 21% growth. This indicates that Dollar Tree could face tougher margin pressures throughout the year.

It also means that Dollar Tree could be in the same boat as Walmart. Walmart recently reported a mixed fourth quarter, which featured a soft full-year profit outlook that broadly missed expectations.

But is Dollar Tree just being conservative?

However, investors should note that Dollar Tree often provides conservative guidance. Its margins also looked healthy during the fourth quarter -- its gross margin expanded 90 basis points annually to 33%, while its adjusted operating margin expanded 130 basis points to 11.7%.

A Dollar Tree store.

Image source: Dollar Tree.

It added 501 stores year-over-year, bringing its total store count to 14,835, as it increased its total retail selling square footage by 3.7% to 116.6 million. Those are the actions of an expanding retailer, not a struggling one.

Dollar Tree also continues to yield multiple advantages against Walmart. Most of its stores are located closer to lower income neighborhoods than Walmart's stores -- which address concerns about time and fuel costs. It sells a growing assortment of private label brands, and it's selling more fresh groceries at its stores.

Dollar Tree also isn't in the direct blast zone of Amazon's (NASDAQ:AMZN) acquisition of Whole Foods. That's because Whole Foods stores are generally located in more affluent neighborhoods than Dollar Tree or Family Dollar stores. Amazon recently turned up the heat on low-end retailers with an "under $10 with free shipping" category, but it's unclear if the platform will actually attract any dollar store shoppers.

The real concern is Dollar Tree's ability to turn around Family Dollar in a timely manner. If Family Dollar's comps continue to trail Dollar Tree's, investors could start to see the brand as a dead weight on Dollar Tree's growth.

Should you buy Dollar Tree?

At $89 per share, Dollar Tree trades at just 16 times the mid-point of its earnings estimate for 2018. That's slightly lower than Walmart's forward P/E of 18.

But unlike Walmart, Dollar Tree doesn't pay a dividend. It's saving its cash to pay off its $5.6 billion in long-term debt, most of which it accumulated from the Family Dollar takeover.

I like Dollar Tree more than Walmart at these prices, but I'm also not bullish on the stock yet. Dollar Tree is well-insulated from the war between Walmart and Amazon, but I'm not confident that it can turn Family Dollar around anytime soon.

 

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.