Five Below (FIVE -1.12%) has found great success through the years by providing consumers with a vibrant shopping experience focused intensely on value. But with growth slowing dramatically in the past few quarters, shares have been under pressure, down almost 22% since hitting an all-time high in August 2021.
Investor sentiment might finally be turning positive, however. Over the past three months, Five Below is up 36% (as of this writing). Is this explosive retail stock a smart buy today? Let's take a closer look at what investors should know.
Catering to a niche customer
As the name suggests, Five Below sells a wide assortment of merchandise, ranging from tech and beauty products to toys and furnishings, for largely under $5 an item. The company's target customers are between the ages of 8 and 14 years old, as well as their parents. While Five Below emphasizes value for its customers, it's worth mentioning the average household that shops there has an annual income of $73,000. That's slightly higher than the median household income in the U.S. of just under $71,000. One would assume that Five Below would attract a lower-income household, but it's clear that seeking out value and stretching your budget is something everyone strives for when making purchases.
Nonetheless, catering to a niche market segment has been an extremely successful business model for Five Below. From fiscal 2016 through fiscal 2021, the company increased revenue at a compound annual rate of 23.3%, with earnings per share rising at a rate of 30.6% during the same time. It's no wonder the stock has soared 177% over the past five years.
That's remarkable growth from a retailer. Credit goes to Five Below's rapidly expanding store footprint, which went from 244 locations at the end of 2012 to 1,292 as of Oct. 29. Management isn't done being aggressive with this strategy, as it believes Five Below can have more than 3,500 stores open across the country by 2030, nearly triple the current number.
This expansion strategy makes sense given the average store requires an initial investment of $400,000, but generates $2.2 million in average yearly sales. With these unit economics, it's a no-brainer decision to continue aggressively opening stores. The end result would be a business that produces far greater sales and profits, ultimately driving the stock higher.
Outlook for 2023
According to the leadership team, Five Below will generate revenue of $3.05 billion for the full fiscal year of 2022, which ends on Jan. 28. That's good for only a 7.1% year-over-year increase. And comparable-store sales, or those from stores that have been open at least 12 months, will decrease 2% to 3% versus the prior year. For fiscal 2023, Wall Street analysts believe sales will jump 17.1%. These forecasts represent a sharp slowdown not only from fiscal 2021's figures, but from the greater-than-20% annual top-line gains shareholders have been accustomed to seeing for most of the past decade.
To be fair, the projected growth numbers are certainly respectable, and that would firmly keep Five Below in the category of being a growth stock. However, investors shouldn't just pay anything for this. Thanks to the price running up in recent months, Five Below's stock currently trades at a steep price-to-earnings ratio of 45. That's more expensive than rivals like Dollar General, Dollar Tree, Walmart, or Target.
Five Below has been a great investment to own over the years, and its recent momentum can be attractive for those looking to get in on the action. However, it's difficult for me to justify paying such a premium valuation multiple, even considering the company's outstanding past growth and promising prospects. Consequently, it's probably wise to pass on the stock right now. If shares come down considerably, then they might warrant a closer look.
