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Five Below's Growth Strategy Explained - Motley Fool

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Five Below's (NASDAQ:FIVE) stock has been a massive winner, soaring more than 400% over the past five years. Primarily selling products between $1 and $5, this $11 billion discount-store chain offers up a broad assortment of merchandise, including beauty and tech products, apparel, and toys. In the past 12 months, it generated trailing-12-month sales and net profit of $2.58 billion and $259 million, respectively. 

The company, which targets tweens, teens, and their parents, is one of the rare success stories today in the brick-and-mortar retail sector. Given its long streak of outperformance, investors need to understand its impressive growth strategy. 

exterior of a Five Below store

Image source: Five Below.

Expanding the footprint 

During the past decade, Five Below has increased its store count more than fivefold. And after opening 34 net new stores in the most recent quarter, there are currently 1,121 locations in 39 states today. This represents an aggressive expansion plan, especially over a period of time when many other brick-and-mortar retailers have struggled. 

Thanks to a treasure-hunt shopping atmosphere, not unlike what you experience at a Costco warehouse, the average Five Below generates more than $2 million in annual sales. This is remarkable considering stores are just 8,000 to 10,000 square feet. The average customer visits 10 times a year, buys 60 items, and spends a total of $150. 

Because Five Below's stores perform so well, it makes sense to carry on with opening more locations. A typical new location requires an upfront investment of $300,000, but generates EBITDA (earnings before interest, taxes, depreciation, and amortization) -- a measure of store profitability -- of $450,000 in the first year. The unit economics are excellent, producing a 150% return on investment. And if we exclude the first half of 2020 when the pandemic took its toll on the economy, same-store sales, a key metric for retail businesses, have increased each year since at least 2008.

Management believes the U.S. has the potential for 2,500 locations, more than double the current footprint. Unsurprisingly, penetrating the country's five most populated states (California, Texas, Florida, New York, and Pennsylvania) will be the company's primary focus. A mix of urban, suburban, and semirural locations also helps Five Below densify specific markets, resulting in marketing and merchandising efficiencies. Supporting this expansion effort are new distribution centers expected to come online this year and in 2022.

Chasing its discount-store rival 

Bigger competitor Dollar General (NYSE:DG), with a market capitalization of $50 billion, operates 17,683 stores in the U.S. and generated sales of $33.7 billion over the past 12 months. While that's almost 16 times as many stores as Five Below, I think Dollar General, as a leader in the discount-store category, provides a relevant comparison.

Over the past five- and 10-year periods, Five Below stock has significantly outperformed its larger rival, and the market's optimism is certainly baked into the stock price today. Five Below's forward price-to-earnings ratio of 39 exceeds Dollar General's more attractive 21. Additionally, the market cap per store for Dollar General is $2.8 million, while for Five Below, it's a whopping $9.5 million, demonstrating the expectation shareholders have for the latter. 

But it's easy to believe that if Five Below's management can continue executing on its ambitious expansion strategy, then the stock will track the tremendous top- and bottom-line growth that should come with more locations. Wall Street analysts' consensus estimates call for Five Below's earnings to more than triple over the next three fiscal years, much greater than the 18% increase expected for Dollar General over that same time period. 

What's more, investors have the chance to scoop up shares in Five Below at a 20% discount from the all-time high it set back in late August. That's a bargain you don't want to pass up.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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