Growth investing can significantly enrich shareholders over the long haul. The key is to pick well-run businesses in the relatively early innings of their growth cycles.
Having parlayed a $5,000 investment in 2013 into $22,400 today, the discount retail chain Five Below (FIVE -0.51%) is a quality growth stock. For instance, this is marginally better than the $21,500 that the same investment amount put into the Nasdaq Composite 10 years ago would now be worth. And Five Below looks like a smart buy for growth investors. Let's dive into the company's fundamentals and valuation to see why.
Robust growth persists
Selling popular and high-quality clothing, toys, and games to a base of tween and teen customers at price points mostly between $1 and $5 has paid off for Five Below. In its 21-year corporate history, the company has steadily grown throughout various economic downturns, including the Great Recession and the COVID-19 pandemic.
| Metric | Q2 2022 | Q2 2023 |
|---|---|---|
| Comparable sales growth rate (YOY) | (5.8%) | 2.7% |
| Total store count | 1,252 | 1,407 |
| Net margin | 6.2% | 6.2% |
Data source: Five Below. YOY = year over year.
Five Below's net sales climbed by 13.5% over the year-ago period to $759 million in the fiscal second quarter ended July 29. Thanks to the great deals the retailer provides its customers, traffic to its stores was up. This is how comparable transactions (e.g., the sum of all transactions at preexisting stores) edged 4.5% higher year over year during the quarter. That growth catalyst was only partially neutralized by a 1.8% decrease in comparable tickets (i.e., the average transaction amount at preexisting stores) for the quarter, which was due to slightly fewer items per transaction. As has been the case for a while now, the major driver of top-line growth was the company's quickly growing store count; adding over 150 new locations to its store count largely explains Five Below's double-digit growth in net sales.
The Philadelphia-based retailer's diluted earnings per share (EPS) rose by 13.5% over the year-ago period to $0.84 in the fiscal second quarter. As a result of disciplined cost management, Five Below's total expenses grew about as fast as net sales during the quarter. That is how the net margin remained steady at 6.2% for the quarter, while net sales and diluted EPS growth rates came in the same.
Image source: Getty Images.
Store openings won't stop anytime soon
Five Below's future looks to be quite promising. The company is nowhere near its full potential: Management anticipates that its store count could surpass 3,500 locations by 2030. Without even considering modest comparable sales growth, this factor alone should be enough to sustain net sales growth.
With a net cash balance expected to come in at around $273 million for the current fiscal year ending in January, Five Below also has liquidity to fund these store openings. And given that the average store takes a mere $400,000 to open, this cash balance itself could open hundreds of stores in the years ahead. To top it all off, the average Five Below store generates more than $2 million in annual net sales. These favorable store economics make it easier for the company to generate additional cash flow to open even more stores.
For these reasons, analysts believe Five Below's diluted EPS will compound by 21.3% annually for the next five years. That is nearly double the specialty retail industry average earnings growth consensus of 10.9%.
Use the recent pullback to your advantage
Shares of Five Below have shed 4% of their value so far in 2023. Combine that with its growing profits, and the retailer could be an interesting buy for growth investors. Five Below's forward price-to-earnings (P/E) ratio has been pushed down to 25.7. This is considerably higher than the specialty retail industry average forward P/E ratio of 15.5. But factoring in its superior growth potential, the stock is deserving of this valuation. That is why I reiterate my buy rating for growth investors at the current $169 share price.
