Dollar Tree has followed the market’s trajectory closely, rising in tandem with the S&P 500 over the past six months. The stock has climbed by 6.3% to $127.21 per share while the index has gained 8.3%.

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Why Is Dollar Tree Not Exciting?

We’re passing on Dollar Tree for now. Here are three reasons we avoid DLTR, plus one stock we’d rather own.

1. Revenue Spiraling Downwards

Reviewing a company’s long-term sales performance reveals insights into its quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Dollar Tree struggled to consistently generate demand over the last three years as its sales dropped at a 11.8% annual rate. This wasn’t a great result and signals it’s a lower quality business.

2. Low Gross Margin Reveals Weak Structural Profitability

We prefer higher gross margins because they not only make it easier to generate more operating profits but also indicate product differentiation, negotiating leverage, and pricing power.

Dollar Tree has bad unit economics for a retailer, giving it less room to reinvest and grow its presence. As you can see below, it averaged a 36.4% gross margin over the last two years. That means Dollar Tree paid its suppliers a lot of money ($63.56 for every $100 in revenue) to run its business.

3. Previous Growth Initiatives Haven’t Impressed

Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? A company’s ROIC explains this by showing how much operating profit it makes compared to the money it has raised (debt and equity).

Dollar Tree historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 7.1%, somewhat low compared to the best consumer retail companies that consistently pump out 30%+.

Final Judgment

Dollar Tree isn’t a terrible business, but it isn’t one of our picks. That said, the stock currently trades at 17.8× forward P/E (or $127.21 per share). While this valuation is reasonable, we don’t really see a big opportunity at the moment. We’re fairly confident there are better investments elsewhere. Let us point you toward the Amazon and PayPal of Latin America.

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