What You Can Learn From Dollarama Inc.'s (TSE:DOL) P/E

When close to half the companies in Canada have price-to-earnings ratios (or "P/E's") below 13x, you may consider Dollarama Inc. (TSE:DOL) as a stock to avoid entirely with its 34.7x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

With earnings growth that's superior to most other companies of late, Dollarama has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

See our latest analysis for Dollarama

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Dollarama.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Dollarama's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings growth, the company posted a terrific increase of 28%. The strong recent performance means it was also able to grow EPS by 95% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 14% per year during the coming three years according to the twelve analysts following the company. That's shaping up to be materially higher than the 9.6% per year growth forecast for the broader market.

In light of this, it's understandable that Dollarama's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

As we suspected, our examination of Dollarama's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Dollarama that you should be aware of.

You might be able to find a better investment than Dollarama. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com