Five Below (NASDAQ: FIVE) is a US growth stock that probably isn’t on the radar of many UK investors. But it’s one that I think is well worth paying attention to.
Despite growing sales at 19% and profits at 15% since 2018, the stock trades at a price-to-earnings (P/E) ratio of 12.5. Even with the prospect of a recession in the US, I think this is far too cheap.
Discount retail
Five Below is a discount retailer that mostly sells things below $5 – a bit like a more expensive Poundland. The main growth avenue for the business going forward involves opening more stores.
At the start of 2024, the company operated 1,544 outlets. It’s looking to expand this by 12% per year to reach 3,500 by the end of 2030.
Opening that many new stores takes a lot of cash. For most retailers, the only way to do this would be to take on debt, putting the balance sheet at risk.
This is where Five Below really stands out though. The average payback period for a new outlet is very short – less than a year, on average.
That means the business is able to finance its growth using its own profits. This removes the need to take on debt and reduces the risk of the company’s growth plans.
At the start of the year, those ambitions came with a high price tag. But after a 69% decline, I don’t think that’s the case any longer.
Why is the stock down?
There are a few reasons Five Below’s share price has been falling. One is a possible recession, which is an issue for a company that gets 45% of its sales from households with an income below $50,000.
Another is theft – with a number of cities no longer prosecuting retail theft, the likes of Five Below are having to spend more on security. The result is higher costs and lower profits.
Both of these are genuine issues for the company that would stop me buying the stock if it was still trading at $215 per share – as it was in January. But at $66 per share, it’s a different story.
With a debt-free balance sheet, Five Below is in a good position to withstand a recession. And after that, I expect growth to pick up again.
It might be difficult for the company to keep growing its revenues at 18% per year in an economic downturn. But over the long term, things look much more positive.
Ultimately, Five Below is aiming to double its sales and profits from last year. And I would expect the stock to do at least the underlying business, even if it takes a decade.
From overvalued to oversold
At the start of the year, I wouldn’t have thought of Five Below as a stock worth considering. But as investors worry about a potential economic downturn in the US, that’s very much changed.
In my view, recessionary fears have caused the market to go from overvaluing the stock to underestimating its growth prospects. As a result, I’m looking to buy it for my portfolio.
