Finding a Quality Discount Retailer

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Five Below is a rapidly growing trend-right, value store for teens and pre-teens. Items at Five Below cost between $1 and $5. But the real key is for Five Below to continue offering trend-right items so it can maintain market share. So far, it has done a nice job in this regard. Actually, it appears as though the company is doing almost everything right. However, there is one key (and simple) reason you might want to use caution when investing in Five Below. 

 


We'll see if this reason to be cautious is enough of a concern that you should stick with a more widely known name in the discount retailer space, such as Dollar General or Target

Five Below keeps climbing higher
Five Below currently has more than 330 stores across 19 states, and it recently opened locations in Austin and Dallas. Thanks to new store openings and strong demand at existing stores, its top line continues to grow. Let's see how it compares to Dollar General and Target on the top line over the past year: 

DG Revenue (TTM) Chart

DG Revenue (TTM) data by YCharts

Five Below has also been growing the fastest on the bottom line over the same time frame:

DG Net Income (TTM) Chart

DG Net Income (TTM) data by YCharts

The charts above might be somewhat misleading. Five Below's top line growth is for real -- no qualms there -- and its bottom-line growth has potential to remain consistent. However, by seeing such rapid growth for Five Below, you might be tempted to discount Dollar General and Target as superior investment options. That would have the potential to be a mistake.

Consider some key metric comparisons:

 

Forward P/E

Profit Margin

Free Cash Flow

Dividend Yield

Debt-to-Equity Ratio

Five Below

53

5.41%

$14.41 Million

N/A

0.24

Dollar General

16

5.90%

$641.58 Million

N/A

0.55

Target

14

3.69%

$6.88 Billion

2.60%

0.91

The charts above might be somewhat misleading. Five Below's top line growth is for real -- no qualms there -- and its bottom-line growth has potential to remain consistent. However, by seeing such rapid growth for Five Below, you might be tempted to discount Dollar General and Target as superior investment options. That would have the potential to be a mistake. All is well for Five Below at the moment. Investors would agree, with the stock appreciating 60.24% over the past year, versus gains of 33.11% and 15.30% for Dollar General and Target, respectively. Furthermore, Five Below sports a healthy profit margin, especially for a discount retailer. Even its balance sheet is healthy. On the other hand, investors are expecting Five Below to continue growing without a hitch, which is evidenced by its lofty forward multiple. If any negative news were to surprise the street, investors would be holding the bag. 

If you look at Dollar General, while top-line and bottom-line growth might not be as fast, its still present, and you don't have to pay a premium, as the stock is only trading at 16 times forward earnings. Additionally, Dollar General sports a healthy profit margin of 5.90%.

Then there's Target, which lags its peers for growth, but it's still growing, especially since its cannibalizing smaller retailers in Canada, and that growth is in its early stages. Target is trading at just 14 times forward earnings, and it yields 2.60%. Target's ability to generate cash flow is significant, which is likely to equate to consistent shareholder returns in the future.

All that said, this doesn't mean Five Below should be avoided. It simply means that while continued growth is likely, risks are high. 

The bottom line
Five Below has the most near to medium-term potential. But that high earnings multiple could lead to trouble at some point down the road. If you choose to invest, you might want to do so with caution. If you're looking for growth and you desire more downside protection, then Dollar General is likely to be a better option for you. If you would prefer to invest in a company that's excellent at generating cash flow and rewarding shareholders, while still seeing growth potential, then you might want to consider Target.

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The article Finding a Quality Discount Retailer originally appeared on Fool.com.

Dan Moskowitz has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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