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Can This Top Canadian Growth Stock Rebound?

question marks written reminders tickets
question marks written reminders tickets

Investing in growth stocks has been a popular trade over the past decade as investors picked high-flying technology stocks which, through the power of internet, introduced new ways of doing things.

But that strategy also has its downside. As investors get used to seeing high-octane growth numbers quarter after quarter, any slippage in expectations can produce a powerful negative impact, as the high P/Es of growth stocks build in big expectations and leave little room for error.

That’s what exactly happened with Dollarama Inc. (TSX:DOL), one of Canada’s top growth stocks that delivered magical return until this June when tide began to turn against this discount retailer and growth hit the ceiling.

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Dollarama stock has lost more than 40% of its value from the 52-week high, as it produced dismal growth numbers in in the past two quarterly reports. Its shares plunged 17% on September 13 – their worst one-day rout – after the retailer reported quarterly same-store sales growth of 2.6% that was half of what analysts had expected.

The company attributed the weak results to a tough comparison with a year earlier and a decision to limit price increases, but skeptics believe that the retailer has peaked in its current growth cycle.

Just to provide you with some perspective, Dollarama has a dominant position in Canada’s discount space. With a massive spending spree on its expansion during the past five years, Dollarama has more than 1,100 stores — a huge jump from the 700 stores it was managing in 2012.

This expansion produced great results for Dollarama’s shareholders, who saw their investments surge more than three-fold, as sales grew at a compound annual growth rate of 12% since 2014, more than doubling the company’s bottom-line profitability.

Is the time right to buy DOL stock?

According to some critics, including U.S. short-seller Spruce Point Capital Management, Dollarama margins are “unsustainable” and its store expansion plans “unrealistic.” The main point of their bearish case is that Dollarama is no more a dollar store after the price increases that have left few items in the store actually costing a dollar.

That argument has its merits, but I believe that problem isn’t unique to Dollarama at a time when many retailers are facing cost pressures, rising wages and U.S.-China trade war. Dollarama, with its dominant position in Canada, will rebound once the macro environment improves and cost pressures wane over time.

I see the current share price drop is an overreaction. In Canada, there is a growing evidence that customers accept items in $3.50-$4 price range, giving management the ability to increase prices and achieve longer-term same-store sales growth of 4%-5%.

Trading at $33.22 and with a robust dividend-growth program, Dollarama can prove a productive long-term investment. That said, investors should wait on the sidelines for a better bargain as I see more downside before the stock begins its upward move.

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Fool contributor Haris Anwar has no position in any stocks mentioned.