Shares of Five Below (NASDAQ:FIVE) were trading sharply higher after the company reported terrific earnings results for the fiscal third quarter after the market close on Wednesday.
Investors got a welcome surprise, as the stock had been dropping in the week leading up to the earnings report, but Five Below is executing at a high level despite the supply chain issues challenging many retailers right now.
The stock is not cheap, trading at a relatively high price-to-earnings ratio of roughly 40, but more results like we just saw could support a higher stock price looking ahead to 2022. Here are three things from the report that highlight why Five Below is such a formidable retail business.
1. Growth where it counts
Total sales increased by 27% year over year. Five Below achieved the highest average store sales in the third quarter in the company's history. The extra demand during the quarter helped offset higher transportation costs and delivered a stellar 75% year-over-year increase in operating profit.
"The ability of our teams to recognize trends and capitalize on them quickly is a key distinguishing characteristic and strength of our model," CEO Joel Anderson said during the earnings call.
It's not a coincidence that Five Below delivered this level of performance in a quarter where consumers are being squeezed with higher prices for goods. Higher inflation could serve as a catalyst for more demand through the fiscal fourth quarter as consumers seek the best value for gifts this Christmas.
2. Delivering value above the $5 price point
One growth catalyst to watch is Five Below's efforts to sell items above its traditional $5-or-less assortment. As the company grows larger and expands its buying power with suppliers, it's able to source higher-priced merchandise and deliver even better quality and savings for customers. Management is pleased with the results so far, citing its recent offering of $12 telescopes and a $25 six-foot basketball hoop.
Moreover, customers who shop Five Beyond products tend to spend more than the average customer. These high spenders clearly contributed to Five Below's record average store sales last quarter. The Five Beyond category should spread to half of the chain by the end of next year. It's currently at about 30% of the business.
3. Room for more store openings
Overall, the biggest contributor to sales momentum is new stores. Five Below opened 52 new stores during the quarter. This brings its total fleet to 1,190 stores across 40 states, but management continues to see the potential for more than 2,500 stores over the long term.
The store count has historically grown about 21% per year. Plus, stores have consistently delivered positive comparable sales growth, excluding the temporary store closures during the pandemic. This gives the company a long-term runway for sales growth.
Most importantly, Five Below has proven it's got a profitable business model for selling goods at ultra-cheap prices, which makes it a resilient retail business during a recession. Consumers are naturally going to shop for more value when the economy softens or inflation spikes, as it has recently. This scenario plays to Five Below's advantage.
Of course, long-term investors should always consider how much value they are getting in return for buying shares in a business. Considering Five Below's opportunities to continue opening new stores, the stock's price-to-earnings ratio of 40 based on this year's earnings forecast doesn't look all that expensive. Investors shouldn't be afraid to start a position in the stock at these levels.