Five Below Inc (NASDAQ:FIVE) relies on hot teen and pre-teen trends, and almost everything it sells is discretionary. That poses a dual threat to the company. First, if its merchandise misses one of the current trends, which will likely happen at some point, its sales would be hurt significantly. Second, if consumer confidence weakens, customers will likely spend less on discretionary items.
Additionally, competition could increase at any time due to a relatively low barrier to entry. Five Below hasn’t fortified its position in the market through a strong geographical presence and brand recognition. However, it’s attempting to accomplish those goals. While they’re not direct threats, dollar stores could still steal Five Below’s market share
Safety in numbers and trends
In addition to real-world threats for Five Below, one of its key metrics might raise investors’ concerns. Five Below is trading at 49 times forward earnings, which makes the stock expensive and sets expectations very high. If Five Below were to run into an unexpected problem in its supply chain, inventory, or anywhere else, then the stock could take a hard hit — every long investor’s worst fear.
While teens and pre-teens don’t often plan to visit Dollar Tree, Inc. (NASDAQ:DLTR) and Dollar General Corp. (NYSE:DG) with their friends, they do shop at these stores for similar items — bracelets, plastic storage containers, markers, folders, notebooks, and more — from time to time. And their parents might also shop at these locations for them.
These dollar stores are likely to be safer investments than Five Below because they sell consumer staples as well as discretionary items. And if the consumer weakens, dollar stores — unlike other retailers — have the potential to actually see increased traffic.
Dollar Tree, Inc. (NASDAQ:DLTR) and Dollar General Corp. (NYSE:DG) are also trading at lower multiples than Five Below: 16 and 14 times forward earnings, respectively. Furthermore, it should be noted that the short positions on these stocks are low, at 1.40% and 2.40%, whereas the short position on Five Below is substantially higher at 14.20%, indicating a lack of broad investor confidence.
History sometimes repeats itself
Five Below founders David Schlessinger and Thomas Vellios started the educational toy store Zany Brainy in 1991. After a phenomenal start, the company filed for bankruptcy in 2001. Schlessinger blamed rapid growth in a sluggish retail environment. This is somewhat concerning, since his current company’s situation is beginning to mirror that of its predecessor.
However, there’s one big difference between Five Below and Zany Brainy thus far, which relates to being overaggressive. Zany Brainy’s acquisition of 60 Noodle Kidoodle stores for $35 million in April 2000, just after the tech bubble peaked, played a significant role in its downfall.
Either Schlessinger and Vellios are on the path to making the same mistake twice due to their desire for rapid growth, or they have learned their lesson, and will effectively grow Five Below organically without making any risky or ill-timed acquisitions.
Conclusion
Five Below’s growth potential is evident, but management seems to be a little too aggressive on its growth goals. Relying almost 100% on discretionary items is a high-risk strategy, and the stock is trading at 49 times forward earnings, which could set it up for a nasty fall. While Five Below still has upside potential, I think its downside risk is too high. You’re likely to be much safer in Dollar Tree, Inc. (NASDAQ:DLTR) or Dollar General.
The article This Specialty Retailer Might Be Growing Too Fast originally appeared on Fool.com and is written by Dan Moskowitz.
Dan Moskowitz has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
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