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3 Reasons To Avoid Five Below

Over the last couple months, I’ve shown you stocks to avoid…

Stocks to consider buying…

And some of the best stocks related to the coming Internet of Things…  Which you can find linked further below.

All these recommendations are to help you either avoid pain and terrible stocks.  Or to help you find potentially great stocks to invest in during this pandemic.

Doing both of things together will help you earn higher than average investment returns and build your wealth.

There are few safe places to invest your capital today. And this number is growing smaller every day this crisis lasts.

The key to continue compounding your capital is to keep investing well over time… Combine this with dividends and you’re well on your way to building a retirement account you can live off.

And this is huge part of things.

But another huge part of this is also losing as little capital as possible.

The fewer investment losses you have the more capital you keep. And the more capital you keep the faster you can invest well to grow your wealth.

Both things are necessary to build wealth. But most only think of investing well. 

Because of this, today I want to show you 3 Reasons To Avoid Five Below.

3 Reasons To Avoid Five Below Stock

  1. It’s Got A Lot of Debt

As of the most recent quarter Five Below’s (FIVE) balance sheet is made up of 63.8% of total liabilities.  And its debt to equity ratio is 1.26.

I want to invest in safe stocks that will be around for decades to come to help me build wealth over the long term.  This helps insure I lose as little money as possible over time.

Typically, this means I invest in companies that have little to no debt compared to their cash and equity.  For example, I like to invest in stocks that have debt to equity ratios below 1.

Its debt to equity ratio of 1.26 may not seem like a big deal… But its also not the full story.

Because instead of normal short and long term debt, Five Below has a large amount of operating and capital leases…  These aren’t counted in the debt to equity calculation or the total liabilities as a percentage of the balance sheet calculation.

But what’s the amount of these leases?

  • $1.04 billion as of the most recent quarterly info.

This is 14.9% of Five Below’s entire market cap of $7 billion.

And its 650% higher than the $160 million it has in cash on hand.

When a company can’t pay its debt it either issues more shares or debt to raise more cash to cover these payments… Or it goes bankrupt.

In this case it would go through a potential eviction from its stores if it couldn’t pay its lease payments.

In normal times this large number of leases wouldn’t be a huge deal… But were not living in normal times right now due to the coronavirus pandemic.

This gets us to our next reason to avoid Five Below… Lower sales and unprofitability due to the coronavirus.

2. It’s Not Producing Enough Profits and Cash Flow

In the most recent quarterly data Five Below was unprofitable on an operating income, net income, and free cash flow basis.  

These all due in large part to negative effects of the coronavirus.

  • Its operating profit in the trailing twelve months (TTM) period was negative $39.1 million compared to positive $60.5 million in the prior year.
  • Its net income was a loss of $21 million in the TTM period compared to a gain of $54.5 million in the prior year period.
  • And its free cash flow to sales (FCF/Sales) margin in this same time was negative 0.7%.

EDITOR’s NOTE – Trailing twelve months just means the last 12 months consecutively.

Generally, you want these numbers to be as high as possible on the positive side because that means the company is generating profits and cash flow from its operations.

For example, I look for companies to have operating and net profit margins above 10% on a consistent basis.

And I look for stocks FCF/sales margins above 5% on a consistent basis.

Why these numbers?

Because after evaluating thousands of companies over the last 13+ years of my career I estimate fewer than 5% of all companies in the world produce consistent operating profit and net margins above 10% over long periods of time.

And far fewer than 5% of all companies consistently have higher FCF/sales margins than 5% on a consistent basis too.

When a company surpasses these thresholds, it means the company is a great operating business.

And these profits allow the company to continually reinvest in and grow its businesses in a healthy way.

But if a company doesn’t surpass these thresholds – like Five Below due to its unprofitability – in time, this leads the company to having less money to reinvest in the business to continue competing well.

The largest problem of this in the immediate future though is that this negative profitability affects Five Below’s ability to make its lease payments which I talked about above.

These show that Five Below’s business is getting hurt by the coronavirus… And yet its stock price keeps going up which gets us to our next reason to avoid its stock.

3. Five Below Is Expensive

For a discount retail store… Man are Five Below shares are expensive.

  • As of this writing its P/E is 70.8.
  • Its P/CF is 39.
  • And its forward P/E is 58.1.

On all three metrics I look to buy investments below 20 to consider them undervalued.

This shows that Five Below is massively overvalued.

And in investing terms this means Five Below stock does not offer you a margin of safety in investing terminology.

When you invest in stocks that are undervalued and have a margin of safety it makes the investment safer.  And it also means you should expect to earn higher returns owning its stock in the coming years.

The inverse of this is also true…

When you invest in a stock that is overvalued and without a margin of safety it makes the investment riskier.  And it also means you should expect to earn less owning its stock going forward.

Why is its stock so overvalued?

Because its share price keeps going up due to people continually buying it… While its profits fall.

When this happens, valuations go up and stocks become expensive.

With Five Below being overvalued it lowers the margin of safety and makes investing in its stock riskier right now.… And it also decreases the investment returns you should expect to own going forward too.

For these reasons I recommend you stay away from Five Below stock.

Use the following links to some of our recent articles to learn other ways to protect yourself and your investments in these uncertain times. 

Disclosure – Jason Rivera is a 13+ year veteran value investor who now spends much of his time helping other investors earn higher than average investment returns safely. He does not have any holdings in any securities mentioned above and the article expresses his own opinions. He has no business relationship with any company mentioned above.

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