Like many investors, I have a watch list of stocks: a running list of companies that require more due diligence before investing. Recently making the jump from the watch list to my portfolio is discount retailer Five Below (NASDAQ:FIVE). It was a decision a long time in the making but one based on solid conviction. Here are five reasons I bought shares.

A teen girl holds up five fingers.

Image source: Getty Images.

1. It has long proved itself as a public company

Investing in an initial public offering (IPO) carries a lot of risk. Stocks tend to be volatile in their first months on the market. But another reason to be leery of IPOs is the fact many of these companies have yet to establish credibility. It takes time before management can build trust by delivering on expectations.

When Five Below filed its S-1 (the document most companies file before going public), it had fewer than 200 locations. It had opened 50 new locations in the previous fiscal year alone with its sights set on 2,000 stores long term. Sure, that sounds impressive. But with less than 150 locations in the comparable-store base, it was reasonable to take this lofty long-term store target with a grain of salt.

Fiscal Year Revenue Net Income Store Count Comparable Sales Growth
2012 $419 million $20 million 244 7.1%
2013 $535 million $32 million 304 4.0%
2014 $680 million $48 million 366 3.4%
2015 $832 million $58 million 437 3.4%
2016 $1.0 billion $72 million 522 2.0%
2017 $1.3 billion $103 million 625 6.5%
2018 $1.6 billion $150 million 750 3.9%

Data source: Five Below. Chart by author.

As you can see, Five Below has experienced at least 19% annual unit growth as a public company, and comps have been positive the whole time. That gives me confidence it indeed can hit its long-term target. 

Furthermore, annual revenue and net income growth have both exceeded 20% every year Five Below has been a public company. That's quite a track record.

So far, the results from 2019 have offered more of the same. Through the first nine months of 2019, revenue is up 21% year over year. Five Below now has 894 stores, up 20% from this time last year. And comps are still positive at 2.4%. Net income, however, is only up 7% (but more on that in a minute).

2. The business model is evolving for the better

Five Below sells low-priced merchandise, and it primarily targets teens and pre-teens. Initially, this market seemed a little too niche to me, and future pricing leverage seemed overly restricted by the company's name.

the exterior of a Five Below location

Image source: Five Below.

In 2018, Five Below began experimenting with its prices by offering a Ten Below section of the store. So far, it's only available in 25 test locations, but management says the reception has been positive. If the company rolls this out across all 900 or so locations in the future, it could boost comps with a higher average ticket and prove that the company, despite its name, has pricing power.

Additionally, Five Below has expanded its target customer to include millennial and Generation X parents. Browse its products, and you'll find fitness items like yoga pants and retro brands like Star Wars merchandise, appealing to both customer demographics. Since parents likely accompany a child to the store, it's only logical to view parents as potential customers as well.

3. It still has a long growth runway

Chains like Five Below primarily drive revenue growth by opening new locations -- unit growth. But it's not always a good idea to open more and more locations. A growing chain needs to have the unit economics to support such a decision.

According to Five Below's investor presentation, it has some pretty good unit economics. The average net investment to open a store is $300,000, but the average store generates $2.2 million in first-year revenue and has earnings before interest, taxes, depreciation, and amortization (EBITDA) of $450,000. When stores perform that well, it makes a lot of sense to open as many as the market will support. While the long-term target was 2,000 locations when Five Below priced its IPO, the target has now increased to 2,500.

To meet this growth target, Five Below needs well-placed distribution centers. It opened a new one in Georgia in 2019 and has three more planned in the next two years. These distribution centers are currently dragging net income down but are absolutely necessary to support the company's expansion. As previously noted, net income through the first nine months of fiscal 2019 is only up 7% year over year. But a lot of the distribution center costs occurred early in the year, and guidance calls for full-year 2019 net income to be up 17% to 20% -- just slightly below the historical average.

4. I got a bargain

On Jan. 13, Five Below released preliminary data for the oh-so-important holiday shopping season. And it wasn't great. Comps unexpectedly fell 2.6%, causing the company to lower its full-year 2019 guidance. The stock sold off furiously as a result, and at one point, shares were down over 20%. Little could I have known that I clicked the buy button at the perfect time that morning. My position is now up over 20%.

I got lucky. I wasn't trying to time the market, since I believe that's impossible. Five Below was merely a company I had already decided to buy, and I had the funds ready. When the stock fell below the price I was willing to pay, I acted opportunistically. 

FIVE PE Ratio Chart

Data by YCharts

When looking at several popular valuation metrics, some might not agree that I got a bargain. But here's how I see it: Five Below's valuation has held steady over the last few years. January's dip below $100 per share gave me a brief moment to buy into what is a relative bargain for this company.

Since I intend to hold the shares for many years, I'm not worried whether right now is the absolute bottom. I'm more concerned with how far and how long it can run.

5. I'm a net buyer of stocks

Fear is a terrible thing, but it's prevalent among investors. And it makes sense. We don't want to see our hard-earned money get wasted on a loser stock. 

The truth is, none of us know what the next month or year holds for Five Below or the market overall. But we can bank on the market going up most years and for bull markets to generally last longer than bear markets. These and other market statistics mean that today is a great day to be a net buyer of stocks.

Am I worried a crash is imminent with markets near all-time highs? Absolutely.

Do I think Five Below's stock could give back some of the 20% gain I already have? I'd be shocked if it didn't.

I try to overcome these fears by regularly adding to my portfolio (like I did with Five Below) whenever I see an opportunity, whether the market is up or down. I'm confident by taking the long view, I'll come out ahead in the end.