For beginners, it can seem like a good idea (and an exciting prospect) to buy a company that tells a good story to investors, even if it completely lacks a track record of revenue and profit. But as Warren Buffett has mused, 'If you've been playing poker for half an hour and you still don't know who the patsy is, you're the patsy.' When they buy such story stocks, investors are all too often the patsy.
In the age of tech-stock blue-sky investing, my choice may seem old fashioned; I still prefer profitable companies like Five Below (NASDAQ:FIVE). Even if the shares are fully valued today, most capitalists would recognize its profits as the demonstration of steady value generation. Conversely, a loss-making company is yet to prove itself with profit, and eventually the sweet milk of external capital may run sour.
How Fast Is Five Below Growing?
If a company can keep growing earnings per share (EPS) long enough, its share price will eventually follow. It's no surprise, then, that I like to invest in companies with EPS growth. Impressively, Five Below has grown EPS by 27% per year, compound, in the last three years. If the company can sustain that sort of growth, we'd expect shareholders to come away winners.
Careful consideration of revenue growth and earnings before interest and taxation (EBIT) margins can help inform a view on the sustainability of the recent profit growth. Five Below shareholders can take confidence from the fact that EBIT margins are up from 7.2% to 13%, and revenue is growing. Ticking those two boxes is a good sign of growth, in my book.
The chart below shows how the company's bottom and top lines have progressed over time. For finer detail, click on the image.
Fortunately, we've got access to analyst forecasts of Five Below's future profits. You can do your own forecasts without looking, or you can take a peek at what the professionals are predicting.
Are Five Below Insiders Aligned With All Shareholders?
We would not expect to see insiders owning a large percentage of a US$9.6b company like Five Below. But we are reassured by the fact they have invested in the company. Indeed, they have a glittering mountain of wealth invested in it, currently valued at US$176m. I would find that kind of skin in the game quite encouraging, if I owned shares, since it would ensure that the leaders of the company would also experience my success, or failure, with the stock.
Does Five Below Deserve A Spot On Your Watchlist?
Given my belief that share price follows earnings per share you can easily imagine how I feel about Five Below's strong EPS growth. I think that EPS growth is something to boast of, and it doesn't surprise me that insiders are holding on to a considerable chunk of shares. So this is very likely the kind of business that I like to spend time researching, with a view to discerning its true value. You should always think about risks though. Case in point, we've spotted 2 warning signs for Five Below you should be aware of, and 1 of them is potentially serious.
Of course, you can do well (sometimes) buying stocks that are not growing earnings and do not have insiders buying shares. But as a growth investor I always like to check out companies that do have those features. You can access a free list of them here.
Please note the insider transactions discussed in this article refer to reportable transactions in the relevant jurisdiction.
What are the risks and opportunities for Five Below?
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.