Optimistic Investors Push Five Below, Inc. (NASDAQ:FIVE) Shares Up 49% But Growth Is Lacking

Those holding Five Below, Inc. (NASDAQ:FIVE) shares would be relieved that the share price has rebounded 49% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 42% in the last twelve months.

Although its price has surged higher, it's still not a stretch to say that Five Below's price-to-earnings (or "P/E") ratio of 18.3x right now seems quite "middle-of-the-road" compared to the market in the United States, where the median P/E ratio is around 17x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

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Five Below hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to strengthen positively, which has kept the P/E from falling. You'd really hope so, otherwise you're paying a relatively elevated price for a company with this sort of growth profile.

View our latest analysis for Five Below

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Five Below.

How Is Five Below's Growth Trending?

In order to justify its P/E ratio, Five Below would need to produce growth that's similar to the market.

Retrospectively, the last year delivered a frustrating 15% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 7.5% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 5.5% per annum over the next three years. With the market predicted to deliver 10% growth each year, the company is positioned for a weaker earnings result.

In light of this, it's curious that Five Below's P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

Five Below's stock has a lot of momentum behind it lately, which has brought its P/E level with the market. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Five Below's analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Five Below, and understanding should be part of your investment process.

You might be able to find a better investment than Five Below. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.