Five Below Is Overvalued

Even after this upbeat quarter, institutions continue to dump their positions in Five Below hand over fist.

Brian Sanders
Brian Sanders
Apr 24, 2014 at 10:44AM
Consumer Goods

Five Below (NASDAQ:FIVE) is a specialty retail company that offers a large variety of accessories for five dollars or less. The company was founded in 2002 and went public in August 2012. It rocketed 53% from $17 to $26 on the date of its IPO, and the rally continued as it surged into the $30's soon afterwards. The stock was already recognized as a great growth story and it instantly became a Wall Street darling. But looking across the industry, Five Below trades at an extremely high multiple and its annual revenue growth of only $100 million does not justify its price to earnings ratio. 

Companies like Family Dollar (UNKNOWN:FDO.DL)Dollar General (NYSE:DG), and Dollar Tree (NASDAQ:DLTR) are the closest competitors of Five Below. The primary strength of these three businesses is that they have already captured a massive amount of market share, and will likely maintain their footholds. While there may not be a discernible moat for any of the following companies, it is difficult to erode market share considering the nature of their industry. Some key metrics comparing these four retailers are below: 

Dollar General seems to be the happy medium in the group, and if analyst projections are accurate then this is the best pick. However, fourth quarter results looked dismal, and there doesn't seem to be any major reason for the results. 

That said, Dollar Tree looks more attractive with the highest margins and best valuation. But investors should be wary of the upcoming earnings report as the company missed analyst estimates on both the top and bottom line in the fourth quarter. 

Family Dollar has been facing the greatest market challenges among these corporations. Not only is the PEG extremely unattractive, but analysts are also not expecting any reasonable growth in earnings for the next fiscal year. Income seekers continue to hold their positions for a 2% yield, but the last report simply affirms the company's unattractive fundamentals. 

Five Below's revenue has been growing each quarter year over year, as expected, while it has posted conservative same-store sales. Its comps have been doing OK, but they're not enticing enough for investors. Its profit margin has moved in-line with comparable businesses, sitting at around 6%. Five Below's management has disclosed a long-term growth target of an estimated 2,000 stores throughout the nation, which is good but yet to be reached. It targets a market group that consists of young people in an attempt to avoid direct competition with other cheap retailers. Evidently the store does have a great young atmosphere that appeals to both the child's eye and the parent's wallet. It has also been well recognized for its proficient management, but has yet to designate a new Chief Operating Officer.

Bottom line
Again, the massive premium shown by a trailing P/E of 65 is likely unjustified. For a growth business, a trailing P/E closer to 40 would be much more reasonable. Although Five Below's decent growth will likely continue going forward, I would have to recommend avoiding this business at a price above $38 per share. Instead I would suggest Dollar Tree, which has the strongest return on assets, price to earnings growth, and profit margin in the relative industry.