At first glance, it’s easy to see why discount retailer Five Below (NASDAQ:FIVE) represents a “Strong Buy” idea among analysts. Providing a wider range of compelling products relative to traditional dollar stores, Five Below seems well positioned if an economic downturn materializes. However, it needs to find another gear if it’s to avoid attracting the bears. Therefore, I am neutral on FIVE stock.
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Conspicuous Underperformance Clouds FIVE Stock
Unlike pure-play dollar stores, most of Five Below’s products feature a price tag of up to $5. Moreover, the company also offers a small assortment of items priced between $6 to $25, meaning that it’s not just financially strapped customers who enjoy shopping at Five Below. Rather, it’s a great place to scoop up hidden bargains. As such, the underperformance of FIVE stock presents a conspicuously worrying picture.
Yes, in the trailing one-year period, shares swung up by nearly 21%. However, year-to-date, FIVE stock is only up about 3%. To be fair, the underperformance itself doesn’t pose significant concerns. Further, Five’s direct competitors – such as Dollar General (NYSE:DG) – have suffered brutal declines. By comparison, FIVE’s volatility seems tame.
Nevertheless, the company arguably ought to be marching northward. Primarily, inflation remains stubbornly high. Despite the Federal Reserve ramping up the benchmark interest rate to cool rising prices, it has so far only achieved modest disinflation. What’s worse, the September jobs report came in much hotter than economists expected. Stated differently, more dollars continue to chase after fewer goods.
Subsequently, it’s not an impossible situation that the Fed may raise interest rates again. Indeed, such a prospect might be likely given the unexpected surge in the labor market. However, higher borrowing costs also apply pressure to everyday households. As businesses are less incentivized to expand under this framework, more layoffs may materialize.
In theory, this pessimistic environment should cynically boost FIVE stock because of the underlying discounts. The fact that it’s not doing so raises eyebrows.
Looking for Another Gear
Financially, circumstances appear favorable for FIVE stock. Unlike Dollar General and similar rivals, Five Below hasn’t sacrificed its gross margins to lift sales. Therefore, it should enjoy flexibility in case the economy sours from here.
In the second quarter of Fiscal 2023, the discount retailer posted $758.98 million in revenue, up significantly from the $669 million posted in the year-ago period. Additionally, its gross profit came in at roughly $265 million, surpassing the year-ago tally of $229 million. Regarding its gross profit margin, there was a slight increase from 34.2% one year ago to 34.9%.
In contrast, Dollar General’s gross margin eroded by 120 basis points during its most recent quarter. Thus, Five Below demonstrates pricing power: it’s able to expand the top line without resorting to price cuts or other margin-killing incentives.
Still, FIVE stock could learn some lessons from Ollie’s Bargain Outlet (NASDAQ:OLLI). In its quarter ended July 2023, Ollie’s gross margin hit 38.2%, well above the year-ago quarter’s print of 31.7%. As well, Ollie’s delivered double-digit-percentage revenue growth. Under this context, it’s not surprising that OLLI has gained almost 56% year-to-date.
A Possible Middle Ground
Caught between two extremes, FIVE stock presents a frustrating narrative. With DG stock falling about 52% since the start of the year, it’s almost the polar opposite of OLLI. However, FIVE doesn’t exactly offer the most compelling deal, up slightly for the year.
Nevertheless, Five could be an interesting idea between the two extremes. With Dollar General, its volatility could be too severe, akin to an attempt at catching falling knives. On the flip side, while OLLI has proven its worth, criticism may exist that it’s gone up too much. So, it’s possible that FIVE stock offers a viable middle ground.
Is FIVE Stock a Buy, According to Analysts?
Turning to Wall Street, FIVE stock has a Strong Buy consensus rating based on 14 Buys, three Holds, and zero Sell ratings. The average FIVE stock price target is $210.13, implying 19.2% upside potential.
The Takeaway: FIVE Stock Needs Something Compelling
Both from a fundamental and financial perspective, FIVE stock appears to be a decent investment. Right now, hurting households can use a discount for everyday goods. Even better, management has been providing said discounts without hurting the company’s margins. Still, the lack of upward mobility in FIVE stock is concerning. Therefore, conservative investors may want to wait until a clear signal materializes.
