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yield hog

John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.

As a consumer, I have mixed feelings about Dollarama Inc.

On the one hand, I buy a lot of stuff there – mainly school supplies, toiletries and household items – because it's cheaper than everywhere else. Even after the chain has steadily raised prices – some items now cost as much as $4 – I'm still amazed at how much I can take home for 20 bucks.

On the other hand, items I buy at Dollarama often break after a week or two. I've had especially bad luck with light bulbs that burn out, pens that fall apart and calculators that suddenly stop working. "We're not getting fooled by Dollarama again," my 14-year-old son vowed after the mechanical pencils I bought him kept breaking.

My ambivalence about Dollarama isn't confined to the merchandise; I'm also of two minds about the retailer's high-flying stock.

It's no secret that Dollarama has been a fabulous investment. Since its initial public offering in October, 2009, the shares have posted a scorching annualized total return of about 40 per cent, blowing away the 7.3-per-cent annualized return of the S&P/TSX composite index over the same period. Dollarama's sales and earnings growth are the envy of other retailers, and there's plenty of expansion still to come: With about 1,100 stores in Canada currently, the company recently raised its target to 1,700 stores, up from a previous estimate of 1,400.

But as a dividend investor who prefers stocks with relatively high and growing yields and conservative valuations, I've never considered Dollarama a good fit for my investing style. Even as the company has raised its very modest dividend at an annualized rate of nearly 15 per cent since declaring its first payment in 2012, the shares still yield a token 0.4 per cent.

Valuation is another concern. With Dollarama trading at about 28 times estimated earnings for the current year, a lot of the chain's future growth has already been baked into its stock price. If anything goes wrong – same-store sales growth moderates, for example – Dollarama's rich price-to-earnings multiple could contract in a hurry. That's precisely what happened to Wal-Mart Stores, whose stock went parabolic from about 1996 to 2000 but spent the next decade or so going sideways even as earnings kept growing. Such is the danger with growth stocks in general, which is why I treat them with caution.

But these are the views of a risk-averse dividend investor who has missed out on Dollarama's spectacular gains. What do analysts say about the stock? For the most part, they remain bullish. Of the 17 analysts surveyed by Thomson Reuters, 12 have a "buy" or "strong buy" rating, four have a "hold" and just one a "sell." The average 12-month price target is $123.06 – a level that Dollarama is already approaching fast. The shares, which have surged since Dollarama posted strong fourth-quarter results in late March, closed Tuesday at $119.28.

Some analysts see lots of gains ahead. In a recent note, analyst Irene Nattel of RBC Dominion Securities said Dollarama's stock could be worth as much as $210 in five years. She cited the expected opening of about 70 new stores a year, Dollarama's recent decision to accept credit cards and the positive impact of higher prices, all of which could contribute to long-term earnings growth of 15 per cent to 20 per cent.

Dollarama's "superior merchandising skills should enable it to profitably grow its market share both geographically and on a category basis," Ms. Nattel said. What's more, given the low penetration of dollar stores per capita in Canada compared with the United States, the company's target of 1,700 stores "is likely a floor, not a ceiling," she said.

If Dollarama continues to raise prices, won't the company eventually drive consumers away? Not necessarily, Ms. Nattel said. Her five-year forecast assumes that the top price point will remain at $4. However, it's not the absolute price of items that matters, she said, but the relative value that consumers perceive.

Rechargeable batteries and sunscreen that cost $4 at Dollarama, for example, are priced more than twice as high at Wal-Mart. As long as Dollarama continues to offer value on a relative basis, it could continue to raise prices, she said.

Still, even some analysts who believe in Dollarama's long-term growth trajectory say the stock – which is up about 20 per cent in the past month – has gotten ahead of itself. Last week, analyst Brian Morrison TD Securities downgraded the shares to "hold" from "buy" and maintained his price target of $125.

"We do view Dollarama as a core holding over the midterm, and absent a change in our thesis, we would become more constructive in our recommendation on a pullback in the share price," Mr. Morrison said.

I'll continue shopping at Dollarama, even if it means buying the occasional piece of junk. But when it comes to investing, I'll stick with what I know best: stocks with modest P/Es and solid – and growing – dividends. I might miss out on some gains, but I could also spare myself from a case of buyer's remorse if Dollarama's stock price stalls.

Yield Hog is part of Globe Unlimited's Strategy Lab series.

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