Five Below Shares Stumble Despite Sales Climbing Over 30%

Five Below (NASDAQ: FIVE) just delivered one of its strongest quarters in years, with same-store sales (SSS) up 23%, fueled by a 19% spike in traffic. Gross margins widened by nearly four percentage points, and earnings per share (EPS) more than doubled year over year.

By any measure, it was a blowout quarter that further legitimizes CEO Winnie Park's "social-first" marketing approach. Yet the stock fell roughly 14% following the news and hasn't recovered.

The company's execution has been impressive, but management's message reinforced investors' concerns about the broader economy. On the earnings call, management warned of "growing macro challenges and an increasingly cautious consumer," citing rising gas prices and persistent inflation.

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After notching 20%-plus SSS growth in the first quarter, management raised full-year guidance for EPS growth from 20% to 33%, but maintained its previous SSS growth projections for the back half of the year.

There's nothing squishy about its social media marketing approach

Five Below's recent results are the product of a strategic overhaul led by the new CEO. There have been several changes, but the one having an outsize effect is its marketing focus on social media, creator content, and viral trends.

This new approach has rapidly grown the rate of new customer acquisition and traffic from brand loyalists. The Squishy Dumpling "event," where the company used social media to create scarcity and drive foot traffic for a new kids' trend, had a meaningful effect on results this quarter and will be a lever management will continue to pull moving forward.

The company also changed how it sells products. The separate "Five Beyond" section, which held higher-priced items, was recently eliminated. Meanwhile, the company has rolled out higher price points on select items, which are now integrated into the rest of the store. This move has lifted the average ticket size while keeping 80% of the store's merchandise at $5.00 or below.

Despite the business momentum, the market is focused on the road ahead. Five Below's core demographic of kids, teens, and their parents is sensitive to economic pressure. If inflation continues to weigh on discretionary spending, even five-dollar toys are at risk.

An off-price model with room to run

For long-term investors, the dual growth story is compelling. The retailer's current footprint includes 1,970 stores, with a long-term target of more than 3,500 locations.

The store-level economics are attractive. New stores bring in $2 million in sales in their first year, on average, with a payback period of about one year on the initial investment. Management plans to open 150 net new locations this year.

A strong balance sheet supports this expansion. The company ended the last fiscal year with $1.1 billion in net cash and no debt. It also generated $412 million in free cash flow (FCF) last year, a jump from $107 million in the prior year as it lapped heavy investments in technology and distribution centers.

This financial flexibility allows the company to self-fund its growth plans and navigate any near-term economic stress. At roughly 21 times this year's earnings, I think the stock is worth buying, but I'd keep some powder dry in case volatility picks up as the year progresses.

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