With a patient approach, growth investing can make investors much richer over the long term. My personal definition of a growth-oriented stock is an underlying business that is consistently generating at least double-digit top-line growth and may or may not yet be profitable.
Specialty discount store chain Five Below (FIVE -0.07%) is a business that fits this profile. Here's why the stock could end up being a savvy buy for growth investors in the years ahead.
Sales and earnings are soaring
Founded in 2002, Five Below is a value-oriented retailer that offers trending and quality products like toys and games and clothing to a mostly younger customer base of tweens and teens. The company's merchandise is mostly priced between $1 and $5 with some value items beyond those price points, such as headphones, phone cases, and portable bluetooth speakers.
This approach has paid off for the company over the years. Five Below's net sales have compounded at 19.2% annually from fiscal 2017 to 2022. And its diluted earnings per share (EPS) have grown at a blistering 20.5% annual clip over that time. Recent results have been strong as well. Five Below's net sales surged 12.7% year over year to $1.1 billion during the fourth quarter, ended Jan. 28.
What was behind these impressive Q4 results? For starters, comparable store sales edged 1.9% higher from a year ago. The strong value proposition of Five Below's products and favorable weather in January also drew more customers into stores, helping to drive 2.8% growth in comparable store transactions. This was only partly offset by a decrease in the comparable average ticket (i.e., the dollar amount of the average transaction).
Store growth has also been incredibly strong, growing 12.6% in the past year to 1,340 locations. All this helped lead to healthy top-line growth for the quarter.
| Q4 2021 Store Count | Q4 2022 Store Count | Growth Rate |
|---|---|---|
| 1,190 | 1,340 | 12.6% |
On the bottom line, Five Below's diluted EPS rocketed upward 23.3% year over year to $3.07 during the fourth quarter. Tight cost management helped the company's cost of goods sold and selling, general and administrative expense categories to rise at slower rates (11.8% and 8.3%, respectively) than net sales. This is what led to a significant improvement in the company's net-profit margin. A 0.9% reduction in Five Below's share count also helped diluted EPS growth outpace net-sales growth in the quarter.
| Q4 2021 Net Margin | Q4 2022 Net Margin |
|---|---|
| 14.1% | 15.3% |
As rapidly as the company has grown, there also appears to be plenty of room for future expansion. Five Below expects to almost triple its store count to more than 3,500 locations by 2030. This is one reason why analysts believe the company's diluted EPS could compound by 16.1% annually over the next five years. For comparison, that is far superior to the specialty-retail industry average earnings growth outlook of 9.6%.
Image source: Getty Images.
The business is financially robust
Accomplishing its goal of tripling store count in just seven years is no small undertaking. But it appears as though Five Below has a viable path to do so.
For one, the company boasts remarkable unit economics on stores. The average Five Below store costs just $400,000 to open and generates over $2 million in annual sales. This provides for a remarkably quick payback on its investment, which can then be used to open even more stores.
Secondly, analysts expect that the company will have a net-cash position of $230 million for the current fiscal year. Put another way, Five Below already has the cash on hand to open almost 600 stores in the next few years.
A rational valuation for an excellent company
Even after a 44% rally in Five Below's shares over the last six months, the stock's valuation doesn't appear to be excessive. Its forward price-to-earnings ratio of 28.8 is well above the specialty-retail industry average of 16. Given its above-average growth prospects and phenomenal financial health, the stock looks like it could be a buy for growth investors at the current $202 share price.
