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Should You Be Tempted To Sell Dollarama Inc. (TSE:DOL) Because Of Its P/E Ratio?

Simply Wall St

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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Dollarama Inc.'s (TSE:DOL) P/E ratio could help you assess the value on offer. Dollarama has a P/E ratio of 21.07, based on the last twelve months. That means that at current prices, buyers pay CA$21.07 for every CA$1 in trailing yearly profits.

See our latest analysis for Dollarama

How Do I Calculate Dollarama's Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Dollarama:

P/E of 21.07 = CA$35.65 ÷ CA$1.69 (Based on the trailing twelve months to February 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each CA$1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

Dollarama's earnings per share grew by -10.0% in the last twelve months. And earnings per share have improved by 22% annually, over the last five years.

How Does Dollarama's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Dollarama has a higher P/E than the average company (13.5) in the multiline retail industry.

TSX:DOL Price Estimation Relative to Market, April 1st 2019

That means that the market expects Dollarama will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

Remember: P/E Ratios Don't Consider The Balance Sheet

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

How Does Dollarama's Debt Impact Its P/E Ratio?

Net debt totals 17% of Dollarama's market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.

The Bottom Line On Dollarama's P/E Ratio

Dollarama's P/E is 21.1 which is above average (14.7) in the CA market. With debt at prudent levels and improving earnings, it's fair to say the market expects steady progress in the future.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Dollarama may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.