Why Five Below Slumped 19.5% This Week

What happened

Shares of Five Below (NASDAQ: FIVE) tumbled 19.5% this week, according to S&P Global Market Intelligence. The specialty discount retailer that sells items below $5 got hit after Target and Walmart reported their quarterly earnings. It also doesn’t help that the broad market indices were down this week as well.

So what

Five Below did not release any earnings or business updates this week. However, both Target and Walmart, large companies in the same industry, reported poor quarterly results. Target’s operating margin is under pressure from both inflationary pressures in freight costs and inventory issues. Apparently, consumers are moving away from home goods/apparel and buying items focused on the beauty and travel industries. These developments caught Target’s management off guard but make sense given the changing dynamics of the U.S. economy coming out of the COVID-19 pandemic. Target stock dropped more than 20% this week because of these developments.

Image source: Getty Images.

Walmart faced a similar fate with its earnings results. Operating income decreased 23% year over year in its latest quarter even though the company delivered solid top-line growth. This shows how inflationary costs can impact a company that operates heavily in the physical world like Walmart.

So what does this have to do with Five Below? Since the company also operates in the retail industry, selling knickknack and gift items, investors are betting the same sort of inflationary/margin pressures are going to hurt its business as well. This caused people to sell off the stock this week.

Now what

As of this writing, Five Below stock is down 43.2% this year, marking one of the worst drawdowns in its history. Even though short-term worries have impacted the stock, management is still optimistic about its long-term growth plans. It eventually wants to triple its store count in the United States to 3,500 locations, and by 2025 it wants to double both sales and earnings per share (EPS). This would equate to an EPS of around $10 in 2025. Compared to its current share price of $117 a share, that is a projected 2025 price-to-earnings ratio of 11.7.

If you believe these inflationary pressures will subside eventually, now could be a good time to take a long-term position in Five Below stock because of its long-term earnings potential.

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Brett Schafer has no position in any of the stocks mentioned. The Motley Fool recommends Five Below and Target. The Motley Fool has a disclosure policy.

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