Down 45% in 6 months, Dollar General stock too cheap to pass up?

Buying a distressed stock while it’s cheap may seem like you’re getting a good deal, but you also need to consider the reasons behind any selling. If there are fundamental problems with the business that are driving away investors, buying puts you at risk of catching a falling knife. It can be difficult to know when or if a recovery will occur.

One stock that has suffered badly this year is general dollar (DG 2.97%). The discount retailer has been feeling the effects of a cash-strapped consumer, and investors are worried its woes could worsen in coming quarters, especially if economic conditions worsen. Is this stock in real trouble, or could Dollar General make a great contrarian investment right now?

Why is Dollar General stock so bad?

Dollar General is down more than 45% in the past six months. Its decline has been so severe that the retail stock is now trading near a seven-year low. The boost it got from pandemic-fueled spending is long gone, and the broader trend has taken over.

The company missed earnings expectations, and when it last reported quarterly results in August, management said its main customer was “financially constrained.” That’s a cause for concern, given that a discount retailer should benefit when consumers become more cash-conscious.

Dollar General’s struggles could point to other problems. Maybe shoppers aren’t finding enough value in its stores. Same-store sales rose just 0.5 percent for the quarter ended Aug. 2, while operating profit fell 21 percent year-over-year.

Dollar General’s profitability problems are unfortunately nothing new, as its already thin margins have been under pressure for years.

Data by YCharts.

One underlying problem is Dollar General’s constant pursuit of expansion. Earlier this year, the chain opened its 20,000th store, but the more locations it opens, the greater the potential for new stores to cannibalize sales from nearby locations, making it harder for those same-store sales figures to remain positive. Over-expansion can do more harm than good in some cases, and to manage those extra stores, the company has to add staff and incur higher overhead, which puts pressure on the bottom line.

How cheap is Dollar General stock?

Dollar General fell to multi-year lows, but with its profit margins shrinking, it might make sense for the stock to settle at a lower valuation. It trades at 13 times trailing earnings at the time of writing, well below its five-year average of nearly 21.

Data by YCharts.

According to analysts’ price targets, which take into account where analysts think the stock will trade in the next 12 to 18 months, Dollar General could rise about 30% from where it’s trading today.

Despite its recent struggles, there’s a case to be made that the stock is trading at too much of a discount, making it an attractive choice for value investors.

Why Avoid Dollar General Stock, Even on Sale

Dollar General stock has the potential to bounce back and generate strong returns for shareholders given its low price, but investors need to be optimistic about management’s ability to turn things around. The biggest concern is the company’s continued expansion in the face of its worsening finances. Management should prioritize cost-cutting and efficiency because if the company is struggling now, it will suffer much more if economic conditions worsen.

As tempting as it may be to buy a stock that looks deeply discounted, the danger lies in assuming that Dollar General stock has bottomed out. There is room for it to fall further, especially if its profits continue to decline.