A 'first look' at Five Below; Beware of making investment decisions amid the evolving election situation
Many investors like to scan the 52-week-high lists for stock ideas, seeking those with "momentum" to hopefully ride even higher...
As a value guy, I'm the opposite.
Emotionally, I love the feeling of buying a stock at a lower price than anyone else in the past year – or, ideally, many years.
But setting emotions aside (which is always critical to successful investing), the biggest winners in my career have usually come from the times when I've been able to purchase the stocks of great companies that encounter short-term (cyclical) difficulties that that market wrongly thinks are long-term (secular) issues and crushes the stock.
In my e-mails over the years, I've written about many such examples: Netflix (NFLX), McDonald's (MCD), Berkshire Hathaway (BRK-B), Amazon (AMZN), Home Depot (HD), Apple (AAPL), etc.
(It's so painful to look at that list and realize I never should have sold any of them. As I've said over and over, you must let your winners run!)
Today's example of one such stock is discount retailer Five Below (FIVE).
To be clear, I am not recommending the stock – rather, I'm sharing my "first look" at a company that meets the basic criteria of what I look for: A high-quality business with a strong record of long-term growth, with a stock that has been obliterated.
I actually wrote about Five Below a year and a half ago in my January 10, 2023 e-mail, in which I discussed many of the retail/consumer companies whose management teams were presenting at the annual ICR conference in Orlando.
Back then, I contrasted Five Below with Boot Barn (BOOT) – writing in reference to Boot Barn's CEO, Jim Conroy:
Conroy concluded by noting that analysts project that Boot Barn will earn $5.70 in EPS this fiscal year (ending in March 2023), about as much as they project discount retailer Five Below to earn next fiscal year (ending in January 2024). (Five Below's management had just presented in the same room half an hour earlier.)
So why, he asked, is Boot Barn's stock at $68.44 per share (equal to a modest 1.5 times sales, 6.4 times EBITDA, and 10.2 times trailing earnings), while Five Below's stock closed yesterday at $186.83 per share, nearly 3 times higher?
As I continued, Conroy offered an interesting answer to this:
The answer, Conroy hypothesized, is that investors and analysts – who are mostly based in places like New York and Boston, where Boot Barn doesn't have any stores – "don't see our customers every day so it's not familiar to them." He concluded by encouraging those in the audience to "go visit our stores and talk to our store associates and customers."
No doubt some of Five Below's valuation premium is due to the belief that the company is likely to grow at a higher rate going forward than Boot Barn (though both businesses, interestingly, have grown revenue at an identical compounded rate of 20% over the past five years), but I think Conroy makes a good point and gives good advice.
(Five Below has a great concept and has executed superbly, so I expect the company will continue to do well going forward... but I wouldn't touch the stock here, trading at 3.8 times sales, 16.2 times EBITDA, and 42.9 times earnings.)
A year later, on January 5 of this year, I followed up with these comments:
So did I see any companies [at the ICR conference a year earlier that] I liked enough to recommend?
Yes – one was Boot Barn, which is the largest western and work-wear retailer in the U.S.
I share a lot of my favorite ideas here in my free investing e-mail, but I save my best ones for my paying subscribers (to learn how to become one here at Stansberry Research, click here).
In that e-mail, I noted that I recommended Boot Barn in the February 2023 issue of my former Empire Investment Report newsletter at my previous firm Empire Financial Research.
In the issue, I detailed the company's long history of steady growth and concluded by highlighting the comparison Conroy made between Boot Barn and high-growth retailer Five Below.
Here's an excerpt from that Empire Investment Report issue:
Conroy pointed out at the ICR conference that discount retailer Five Below is expected to earn $5.65 in in 2023 – a bit less than BOOT – but its stock is around $200 per share! So why, he asked, is Boot Barn's stock valued so much lower?
The answer, Conroy hypothesized, is that investors and analysts – who are mostly based in places like New York and Boston, where Boot Barn doesn't have any stores – "don't see our customers every day, so it's not familiar to them." He concluded by encouraging those in the audience to "go visit our stores and talk to our store associates and customers."
That's excellent advice...
No doubt some of Five Below's valuation premium is due to the belief that the company is likely to grow at a higher rate going forward than Boot Barn, but it's not at all clear that this will be the case, as both businesses have grown revenue at an identical compounded rate of roughly 20% over the past five years.
In summary, I liked BOOT and thought FIVE shares were overvalued.
That turned out to be a remarkably prescient call...
As you can see in the chart below, since January 5 through Friday's close, BOOT shares are up 68% while FIVE shares have crashed by 62%:
So having successfully avoided the collapse, let's take a look at Five Below to see if it might be one of the rare and profitable babies thrown out with the bathwater...
Before I look at guidance from a company or read any analyst reports, I always first look at the cold, hard facts – a company's long-term financials. Unless there's fraud involved, these give me a lot of valuable information.
I like to start by looking at a company's revenue and operating income (a better measure than net income because it excludes weird things like tax changes and one-time or non-cash charges). Here's what these look like for Five Below:
Overall, this is an impressive track record of steady, high growth... though earnings, after initially dropping and then spiking during the pandemic, have flatlined over the past two years.
Does the cash-flow statement reflect this as well? Let's take a look:
This is also a solid story, as the company has been consistently free-cash-flow positive.
So what has Five Below done with the substantial cash flows it generates?
It has mostly, as you can see from the capital expenditures ("capex") in the chart above, invested in growth (i.e., opening new stores). But the company has also begun to repurchase shares (it has never paid a dividend), as you can see here:
However, these share repurchases haven't really moved the needle... as $118 million spent on this in the past year is insignificant in the context of a $4.3 billion market cap today (the share count is only down 1.4% over the past two years).
Lastly, I always take a look at the balance sheet, in particular net debt (debt and operating leases minus cash). Here's what it looks like for Five Below:
At first glance, this might look like an alarming trend... but it's not.
Five Below has no debt whatsoever – the chart above reflects operating leases, which are common for a retailer. And net debt is only 1.7 times the company's trailing 12-month earnings before interest, taxes, depreciation, and amortization ("EBITDA") – a low figure.
In summary, I like what I see based on my first look at Five Below's historical financials. And I like what I see on the stock chart, which reflects a 62% decline in the share price since late March.
In tomorrow's daily, I'll continue my analysis by looking at what has caused the stock's collapse and whether it's a value trap or possibly a great buying opportunity... Stay tuned!
2) I'll conclude today with a reminder about something I've mentioned several times this year...
In Friday's e-mail, I wrote about all of the swirling political uncertainty these days and urged my readers to tune out the noise, concluding:
If you want to be a successful investor over time, don't let your personal politics – or your emotions – affect your analysis of economic factors and your investment decision making.
Well, the noise is only louder today in light of President Joe Biden's decision yesterday to step aside as the Democratic nominee in the coming presidential election.
According to real-money betting odds sites PredictIt and Polymarket, Vice President Kamala Harris is more than 80% likely to replace President Biden as the Democratic presidential nominee.
I'll note that my contrarian view is that, while she's certainly the favorite, odds that she's the nominee after the Democratic National Convention (which starts four weeks from today) are, at best, 50/50.
To be clear, this is not a political statement for or against her – I do my best to keep my political views out of my investing e-mails.
Rather, I am simply observing on statistical analysis website FiveThirtyEight that her approval/disapproval rating is deep underwater (38.6% approve versus 50.4% disapprove... close to Donald Trump's favorable/unfavorable opinion rating at 41.7% favorable versus 53.7% unfavorable). And a wide range of national and swing-state polls are unfavorable for her, to say the least (you can review her polling on FiveThirtyEight here).
If Harris' long-standing negative numbers persist, I think Democrats are likely to pick another nominee to improve their chances of winning in November. (Again, I'm not expressing any opinion on whether this would be a good thing or not – I am simply predicting what I think is likely to happen, not what I want to happen.)
The key word here is "think"...
All of this is an evolving situation. We're still about a month out from the Democratic convention... and even further out from actual Election Day. And as we all know, anything can still happen between now and then.
As I also said on Friday:
There are too many moving pieces to have any degree of conviction about how the election plays out.
I feel the same way today. That means not doing anything rash with investing decisions in light of what happened over the weekend.
As the election cycle continues to move forward, you can bet that the noise will keep getting louder. So it's important as ever to keep a calm, level head.
And not be a broken record... but again, don't let your political beliefs – or your emotions – affect your analysis of economic factors and your investment decision making!
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.