Last week, Five Below (NASDAQ:FIVE) reported strong second-quarter results that propelled Five Below stock up 13% on Friday alone, bringing its year-to-date gains to just shy of 100%. While FIVE stock more or less moved sideways from 2012 to 2016, it has been a rocket since then.
Explaining the Impressive Rally of Five Below Stock
Five Below brings a fun vibe to discount shopping, enabling it to attract kids, teens, and even twenty-somethings into its vibrant variety stores—of which there are now more than 600 in 32 states. And that fun vibe is powering its sales, and consequently Five Below stock, higher.
Do you want a new phone case and headphones? A fun graphic tee-shirt? Some cheap make-up? Brightly colored school supplies? Five Below is the place to go. The chain offers deep discounts like Walmart (NYSE:WMT) and Dollar Tree (NASDAQ:DLTR)—which is important in the wake of stagnant wages and rising income inequality—but FIVE doesn’t have the stigma of those brands.
Five Below’s Q2 results featured a 3% increase in same-store sales, a 23% increase in overall sales, and a 49% increase in net income. “We saw broad-based strength across our worlds as our high quality, trend right products at incredible values continued to resonate with customers,” CEO Joel Anderson said in a statement.
One of the positive catalysts for Five Below stock, in my opinion, is that its name is a misnomer. Everything in the store isn’t actually five dollars or below. That is part of the reason why FIVE has been able to boost its profit margin to 9%. By comparison, Walmart’s profit margin is 1%, CVS’ (NYSE:CVS) profit margin is 2%, and even Target (NYSE:TGT), which is also an upscale discount retailer, has a profit margin of 4%.
In 2018, FIVE’s sales are expected to reach at least $1.53 billion thanks to 125 new stores and a roughly 3% bump in comparable store sales. On the bottom line, Wall Street is currently expecting earnings of $2.48 per share, good for 38% growth, though the company provided 2018 EPS guidance of $2.51 -$2.57 in its recent report.
The Elevated Valuation of Five Below Stock
The problem, however, is that FIVE stock now sports a forward price-earnings ratio of 44. That valuation is a bit frothy, given FIVE’s long-term guidance of 25% annual earnings growth on the back of 20% sales growth. And that’s just one reason it’s safe to say FIVE stock has likely gotten ahead of itself.
Analysts’ average price target on Five Below stock, according to Yahoo Finance is $108. But in the wake of its recent gains, FIVE stock has soared past that target, reaching around $120 in this morning’s trading.
Research firm Dougherty downgraded Five Below stock to “neutral” due to valuation last week, while Credit Suisse moved FIVE stock to “neutral” from “outperform” in July, saying that all of the good news was already price into Five Below stock.
I have to agree with Credit Suisse. I like Five Below’s business model and growth, but I don’t like its valuation. It’s easy to see why the stock has doubled this year—such outsized growth is especially hard to find in the retail world—but those sizzling gains also make it easy to see why new investors are best-served staying on the sidelines.
As of this writing, Robert Martin did not hold a position in any of the aforementioned securities.