What happened
Shares of Dollar Tree (DLTR 0.71%) tumbled 18% in August due to forward-looking comments in its earnings report. Investors are worried about pricing pressure and weakness among consumers over the next few months.
So what
Dollar Tree's quarterly results were mostly positive. Its revenue and earnings met Wall Street's forecasts, as same-store sales increased 5%. Instead, investors were focused on the company's outlook, which wasn't particularly bullish.
Management noted some weakness in the Family Dollar portion of its business, which represents roughly half of consolidated sales. Family Dollar only grew 2% last quarter, and the profit margins for that chain are much lower. In the earnings release, management outlined plans to use "price investments" to improve its competitive position. That's a delicate way to say that Family Dollar will be cutting prices to keep shoppers from going elsewhere.
Image source: Getty Images.
This isn't the worst news ever, but it's a step in the wrong direction. This will inhibit growth, and margins will get worse. It also signals more-ominous general economic trends. Consumers are still struggling with lingering inflation, and the Fed's rate hikes in response are raising concerns that economic activity will slow. A recession could trigger rising unemployment and slowing wage growth. If consumer sentiment is bad, then discount retailers like Dollar Tree could struggle.
Now what
Dollar Tree had been a solid performer this year coming into August. Investors have been fleeing growth stocks in favor of value stocks, which was great for lots of stable consumer staples stocks. The stock's forward price-to-earnings ratio was approaching 23 last month, which is fairly high in today's market for a low-growth, narrow-margin business like Dollar Tree. That set it up for failure the minute bad news came around, and that's what happened.
The company's sour outlook isn't great news, and it's a storyline that could impact the stock next quarter if things continue in this direction. Still, it's a much more defensive business than high-flying tech stocks. That should help support the stock if we see a market downturn over the next few months.
A share repurchase program helps improve returns, but Dollar Tree isn't a dividend stock like some of its consumer-staples peers. This is an interesting opportunity to minimize risk while maintaining equity exposure, but it's not suited to growth or income roles in your investment portfolio.
