Dollar Tree (DLTR) shares dropped sharply last week as the company fell short of earnings estimates and reduced its profit outlook for the full fiscal year. The discount retailer cited "elevated shrink and unfavorable sales mix" as the reasons for the shortfall.
Now that the stock is well off its highs, is it time to buy Dollar Tree? Let's go to the charts to find out.
Last week's news pushed the stock down to a support level, located near $135 (point A). This level has been in play since September of last year and has survived numerous tests since that time (green dotted line). If the stock falls below that line, consider it a bearish signal.
Source: TradeStation
Now that Dollar Tree has bounced from support, revealing the presence of persistent buyers, I'm also going to buy. I'll place a stop below $135 (point B). That stop will be raised if the stock's price exceeds $150, thereby reducing the risk of the trade.
My initial target for the trade is $160, where I hope to close half this position (point C). This target is just below the stock's recent high print of $161.10 (blue dotted line), which occurred on May 19.
My second target is $175 (point D). That level is just below Dollar Tree's highest print in the past 52 weeks (black dotted line).
One reason to own Dollar Tree is the potential for a recession later this year. A recent Bloomberg survey shows recession odds increasing to 65% from 60% as higher interest rates and tighter credit conditions work their way through the U.S. economy. If consumers are faced with reduced buying power, Dollar Tree and other low-end discount stores should see more traffic.
The shrinkage issue is a fairly recent and growing phenomenon. Target (TGT) expects to lose about $1 billion from theft and fraud in 2023, doubling the figure from the previous year.
Will Dollar Tree follow the lead of TJX Companies (TJX) , which has increased spending on in-store security? That might be difficult due to Dollar Tree's lower price points. Instead, Dollar Tree is considering restricting access to some products, similar to the approach taken by Target and CVS (CVS) .
Dollar Tree has nearly 8,000 stores in 49 U.S. states and territories. I'm unconcerned with the shrinkage issue because it is not company-specific. This is a short-term trade, not a long-term investment.
