Physical shopping undoubtedly took a major hit during the pandemic with lockdown orders and temporary store closures seriously impacting brick-and-mortar retailers. The industry was already in a secular decline before the health crisis, which simply exacerbated the problems. Consumers can increasingly find everything they need online.
However, discount chain Five Below (FIVE -0.07%) has fought this trend with smashing success. Its stock is up fourfold over the past five years. Yet since the start of 2022, it's fallen 25%. This presents investors with a rare opportunity.
Here's why this unstoppable discount retailer looks like a solid investment today.
Image source: Getty Images.
Offering a vibrant shopping experience
Five Below sells a wide range of merchandise, ranging from toys and games to apparel and home décor -- and primarily under $5. Stores are defined by vibrant colors and displays with products split up into eight different shopping categories: Play, Tech, Create, Party, Candy, Style, Room, and New and Now. Branding itself as a fun shopping destination for teens, the company has found monster success by carving out a niche in the discount space.
The retailer reports fiscal fourth-quarter 2021 financial results some time in March. Although the business will certainly have some tough comparisons to the prior-year period when same-store sales jumped 13.8% year over year, a strong holiday quarter seems likely. That's because during an economic environment like we've been experiencing lately -- one characterized by extremely high inflation -- consumers will look to stretch their dollars. This setup favors Five Below and its affordable items.
The company opened 52 new stores in the latest quarter (ended Oct. 30) and currently has 1,173 in total. But management believes that Five Below can one day have at least 2,500 locations in the U.S. This is in stark contrast to most other physical retailers that are shuttering locations.
Superb financials
Growth stocks aren't usually known to produce consistent profits, but that's exactly what Five Below has done. Throughout the first three quarters of fiscal 2021, the company generated $138.6 million in net income. And in the current quarter, management is forecasting around $136.5 million in profit on roughly $1 billion in revenue. Five Below has been profitable in each fiscal year over the past decade.
The unit economics are exceptional. Each Five Below location costs approximately $300,000 to build but averages $450,000 in earnings before interest, taxes, depreciation, and amortization in the first year. That's a ridiculous return on invested capital of 150%, a target any business would strive to achieve, let alone a retailer.
With such strong financial metrics and a sound balance sheet that has zero debt, it's no wonder Five Below carries on with an aggressive expansion plan. As long as the numbers continue looking this good, shareholders should want management to keep opening more stores as this will ultimately lead to greater profits and a higher stock price over time.
Let's look at the valuation
I'll end by touching upon valuation. After the 25% price drop seen so far this year, Five Below's stock currently trades for a price-to-earnings ratio of 33. Besides March 2020, when the pandemic first rocked markets, this is the cheapest the stock has sold for in almost four years. For a company that has increased sales 895% and net income 1,657% from fiscal 2010 through fiscal 2020, the valuation makes Five Below's stock look like a screaming buy right now.
If we factor in the expansion opportunity ahead and management's long-term plan to more than double the domestic-store footprint, it's very difficult to make a case against owning shares.
