3 Reasons Five Below Is a Must-Buy for Long-Term Investors

Source The Motley Fool

Five Below (NASDAQ: FIVE) is a retail chain of 1,749 locations as of the end of the third quarter of 2024. The chain is popular with teen and preteen shoppers who are looking to get trending products at cheap prices. And the stock is a must-buy for long-term investors. I believe that they will want to own Five Below stock through at least 2030, if not beyond.

And to support this belief, I'll share some thoughts from some of the greatest long-term investors of all time: Peter Lynch, Warren Buffett, and Charlie Munger.

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Peter Lynch: "Buy what you know"

This past holiday season, there was one place that my kids and my friends' kids wanted to go shopping for gifts: Five Below. This isn't reason enough to invest in a stock. But in the words of Peter Lynch, a good way to start investing is to "Buy what you know."

For me, Five Below has gone from a brand that I only saw when traveling, to a chain with a store about 30 minutes away, to a company with a store in my hometown. At the end of 2019 -- only five years ago -- it had 900 locations.

It has nearly doubled since then. If it seems like I'm seeing it more these days, it's because I am.

At its investor day presentation in 2022, management said that it anticipates having more than 3,500 locations someday. Perhaps some investors believe this number is too high to be achievable. But even so, the company could open new locations at a brisk pace of 100 stores annually through 2030 and still not come close to its stated goal.

Lynch famously invested in many retail and restaurant concepts when they were in expansion mode, like Five Below is. These consumer-facing businesses were good opportunities, and it's why I think Lynch might have been intrigued with Five Below's expansion if he were still professionally managing money today.

Warren Buffett: "Never lose money"

I believe it's unlikely that long-term investors will lose money with Five Below stock. And that would be music to Warren Buffett's ears. His top investing rule is to never lose money. And his second rule is to always remember the first rule.

As Lynch often pointed out, a stock's price is strongly correlated with a company's earnings over the long term. Therefore, if profits go up, the stock price will likely go up as well. I believe investors will make money in Five Below stock because its earnings will almost certainly go up.

According to management, Five Below stores have a payback period of about one year. This means that if it costs $400,000 to open a new store, that store should profit $400,000 in its first year of being open. In subsequent years, overall profits increase because the investment is already paid off.

This is exactly what's happened with Five Below over the last five years. Its earnings per share (EPS) are up more than 50%, as the chart below shows.

FIVE Revenue (TTM) Chart

FIVE revenue (TTM), data by YCharts; TTM = trailing 12 months.

Granted, its revenue has doubled during this time -- so ideally EPS would be up by a greater amount. But the point remains: Five Below's profits are going up, which is the fundamental catalyst the stock needs to go up.

Charlie Munger: "The big money ... is in the waiting."

I can almost hear the detractors now: "Five Below's earnings are up more than 50% in the last five years, but the stock price is down 18% during this time, and it's down more than 60% from its all-time high." Of course, that's true. And investing great Charlie Munger was the first to point out that top stocks pull back 50% or more regularly.

Zooming out, Five Below stock was outperforming the S&P 500 from the beginning of 2020 through early 2024 -- that's the long term. By contrast, its underperformance is a short-term problem. The company is facing headwinds such as turnover in key management positions as well as a modest decline in same-store sales.

Munger would encourage investors to not react emotionally to Five Below's recent drawdown. If it's a good business, and I believe it is, then it will rebound as its earnings continue to climb.

Perhaps Munger's most famous quote is that "The big money is not in the buying or the selling but in the waiting." And I think that will be true here. I don't believe it's unreasonable to expect the company's profits to double between now and 2030, as it continues to expand. And considering it's debt-free, management will either funnel those profits into new opportunities for growth or give them back to shareholders.

In conclusion, Five Below is a growing, consumer-facing business like the ones that Peter Lynch used to look for. It has a clear path to earnings growth, making it unlikely to lose money, which is Buffett's top rule. And considering its cheap stock price and solid financials, it's one to calmly hold for the long term, as Munger suggested, so that the big investment gains can ultimately be realized.

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*Stock Advisor returns as of January 13, 2025

Jon Quast has positions in Five Below. The Motley Fool recommends Five Below. The Motley Fool has a disclosure policy.

Disclaimer: For information purposes only. Past performance is not indicative of future results.
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