Dollar General has had an impressive run over the past six months as its shares have beaten the S&P 500 by 7.4%. The stock now trades at $114.50, marking a 13.8% gain. This was partly thanks to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
Is there a buying opportunity in Dollar General, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Why Is Dollar General Not Exciting?
We’re happy investors have made money, but we're sitting this one out for now. Here are three reasons we avoid DG and a stock we'd rather own.
1. Long-Term Revenue Growth Disappoints
A company’s long-term sales performance is one signal of its overall quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Unfortunately, Dollar General’s 4.1% annualized revenue growth over the last three years was sluggish. This fell short of our benchmark for the consumer retail sector.
2. Low Gross Margin Reveals Weak Structural Profitability
At StockStory, we prefer high gross margin businesses because they indicate pricing power or differentiated products, giving the company a chance to generate higher operating profits.
Dollar General has bad unit economics for a retailer, signaling it operates in a competitive market and lacks pricing power because its inventory is sold in many places. As you can see below, it averaged a 30.2% gross margin over the last two years. That means Dollar General paid its suppliers a lot of money ($69.84 for every $100 in revenue) to run its business.
3. EPS Trending Down
Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.
Sadly for Dollar General, its EPS declined by 13.8% annually over the last three years while its revenue grew by 4.1%. This tells us the company became less profitable on a per-share basis as it expanded.
Final Judgment
Dollar General isn’t a terrible business, but it doesn’t pass our quality test. With its shares topping the market in recent months, the stock trades at 15.7× forward P/E (or $114.50 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. We're pretty confident there are superior stocks to buy right now. We’d suggest looking at one of our all-time favorite software stocks.
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