The S&P 500 continues rewarding investors. After climbing 24% in 2023, the benchmark index finished 2024 up 23%. That's a tremendous 24-month gain.
But not all companies have benefited from the rally. Five Below (FIVE 3.48%), which sells a broad range of merchandise targeting teens and tweens with a price point typically under $5, currently trades a gut-wrenching 57% off its peak from August 2021 (as of Jan. 6).
Is it time to buy the dip on this growth stock?
Five Below's aggressive expansion
Five Below is a discount retailer that is growing rapidly across the country. As of Nov. 2, it operated 1,749 locations, a figure that's nearly double the total exactly five years before. Even though this rate of growth is unbelievable, management isn't close to being finished.
The goal is to continue the aggressive expansion to get to 3,500 stores by 2030. This implies that over the next five or so years, the footprint will double. You'd struggle to find any brick-and-mortar retailer trying to grow like this.
According to Statista, there are 38,000 discount stores in the U.S. Even if Five Below hit its target of 3,500, it would still be tiny in the grand scheme of things. It will be substantially smaller than the leader in the industry, Dollar General, which currently operates more than 20,000 locations.
There's expansion potential in some of the country's most populated states. Five Below is focused on building its presence in California, Texas, Florida, New York, and Pennsylvania. Of course, it's important that the business places these stores in locations that lead to major incremental sales and profits to minimize cannibalizing nearby locations.
Opening new stores has unsurprisingly led to fast revenue gains. The top line was up 14.6% year over year in Q3 2024. And in the past five years, it has increased by 95%.
NASDAQ: FIVE
Key Data Points
Issues can't be ignored
However, investors who dig beneath the surface will find some problems, especially in recent times. One of the most important performance metrics for any retailer is same-store sales. Five Below's same-store sales were up just 0.6% in Q3. For the last nine months, they're actually down 2.6% compared to the same period last fiscal year. Clearly, the company is struggling to boost foot traffic at its locations, which is a troubling sign.
Profitability has also taken a hit due to significantly higher selling, general, and administrative expenses. As a result, Five Below reported an operating loss of $606,000 in the third quarter versus a $16.1 million operating profit in the year-ago period.
I believe this points to just how competitive the retail sector is, especially when it comes to controlling costs, keeping fresh merchandise on the shelves, and driving traffic to stores. Five Below goes up against other discount chains, as well as industry heavyweights like Walmart and Amazon, which all target value-conscious shoppers. It's incredibly difficult to maintain lasting success against companies that have virtually unlimited financial resources to better serve customers.
Discount valuation
Five Below's growth is notable, but its key financial metrics continue to be discouraging. Plus, it's difficult for investors to argue that the business possesses an economic moat. Competition is too stiff in the discount retail sector.
However, the stock itself trades at a discounted valuation, at least when compared to the S&P 500. Five Below shares can be purchased today at a price-to-earnings (P/E) ratio of 21, near the cheapest level in the past 10 years. The broad index's P/E multiple is under 25.
Based purely on a valuation perspective, I can understand why investors would still be inclined to take a closer look at Five Below as a portfolio addition. This is especially true if you're turned off by what appear to be elevated valuations across the investment landscape.
But I believe buying Five Below stock would be a mistake. Until the company can start to register healthy same-store sales growth and improve profitability on a consistent basis, it's best to stay far away. Even then, the lack of durable competitive advantages is a red flag for me.
