3 Must-Know Facts About Five Below You'll Want to Check Out Before Buying the Stock

Shares of Five Below (NASDAQ: FIVE) are on the way up. Since hitting their 52-week low in August, they have skyrocketed 60% (as of the Dec. 12 close). The momentum is clearly strong with market sentiment improving.

But in the past five years, this retail stock is still down 14% with a jarring 51% drop year to date. If you're thinking about investing in Five Below, here are three things you need to know before making that call.

Opening more stores

For any retail-based operation, a key component of growth is increasing revenue from each existing location, often measured as comparable sales, as well as opening new stores. In Five Below's case, the latter has been the focal point of its strategy.

After opening 82 new locations in fiscal 2024 Q3 (ended Nov. 2), the business had 1,749 stores nationwide. That number was almost double the count from exactly five years ago. Unsurprisingly, this has led to tremendous revenue gains with sales rising 124% during that stretch of time.

It makes sense why briskly opening new stores is the emphasis. Each location generates over $2 million in sales and about $500,000 in adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in the first year. However, they only cost an average of $500,000 in upfront capital investment to open. Those unit economics are hard to ignore.

Management has set an explicit goal to have 3,500 stores open by 2030. There is still a lot of potential to expand in populated states like California, Texas, Florida, New York, and Pennsylvania. Should the pace of expansion continue toward that target, it's a virtual certainty that revenue will be significantly higher than it is today.

Key metrics under pressure

Five Below might be spending aggressively to open new locations, which is boosting the top line. However, the company is showing weakness in a couple of key performance metrics.

Comparable sales were up just 0.6% in Q3. This marked an improvement after two straight quarters of declines. CFO Kristy Chipman said during the August earnings call, "Customers remained discerning with their discretionary spending."

That's certainly a problem, demonstrating the company's struggle to increase revenue at existing locations (those open at least 15 months). It's also concerning negative comps are likely to return. Management expects a 3% to 5% same-store sales drop in the current quarter.

Profitability is also taking a hit because of higher labor costs. Five Below reported an operating loss of $0.6 million in the fiscal third quarter after generating $16.1 million in operating income in the year-ago period. For what it's worth, the leadership team slightly upped earnings guidance for fiscal 2024, so it should get back to black.

Five Below's valuation

While Five Below stock has soared since mid-summer, it has disappointed investors over the long haul and underperformed the S&P 500 going back a decade.

With that type of disappointing performance, you'd think Five Below's valuation would be a screaming bargain, but that's just not the case. As of this writing, the stock can be purchased at a price-to-earnings ratio of 21.4, only a 16% discount to the S&P 500 average.

Investors seeking out growth-focused retailers might find Five Below's potential turnaround compelling. However, I believe the company needs to show concrete and sustainable improvement in its profitability and same-store sales before becoming worthy of an investment.

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Neil Patel has no position in any of the stocks mentioned. The Motley Fool recommends Five Below. The Motley Fool has a disclosure policy.