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Is This the Best Discount Retailer Stock on the Market?

Rich Duprey, The Motley Fool

In a segment of the retail space that is generally achieving record growth, there may be no better business than Five Below (NASDAQ: FIVE), the deep-discount retailer that sells everything for $5 or less. As full-price chains close stores at an alarming rate and discount retailers begin to stumble, this deep discounter not only looks resilient but is expanding at an exponential rate.

The perfect price point

The $5-and-below price level has become the sweet spot for deep-discount retailers such as Dollar General (NYSE: DG), which has more than 80% of its SKUs at that price point, and Dollar Tree (NASDAQ: DLTR), where everything is priced at $1 in its namesake stores (its Family Dollar chain also has a preponderance of goods sold in the $5-or-less price range).

The deep-discount chains have been among the most consistent performers when times are good or bad. The more recent success of the so-called dollar stores has been predicated on adding refrigerator and freezer sections to stock more consumables, and even fresh food and produce.

But Five Below is different. Its winning formula isn't grounded in food but rather in finding "trend-right" products that it can sell for $5 or less, and having found them, sell them for all they're worth.

Boy with fidget spinner

Image source: Getty Images.

A finger on the pulse of consumer interests

Five Below has what it calls eight "worlds," including sports, tech, crafts, and party. Within each segment, it pursues major trends, such as the fidget spinner craze (which is now slowing) or the Silly Bandz one before it. It also focuses on the popularity of characters from Star Wars and Disney's Frozen, for instance, with its evergreen licensed products. There's a third aspect to its strategy -- the retailer calls it "relevancy" and that can be something as simple as putting popular mermaids on the blankets it sells. 

Thanks to buyers who are tuned in to trends that are turning hot, Five Below has been able to achieve 11 consecutive years of positive comparable sales growth.

Expansion afoot

For the third quarter, it was able to grow sales at an 8.5% rate, well above the 3% to 5% range it had been predicting, but when you're able to sell a drone with a camera for $5 (something Five Below offered for a week in November, while supplies lasted, to those spending at least $45), you're going to get a lot of repeat business as people look for "hot stuff" at "cool prices."

The exterior of a Five Below store

Image source: Five Below.

The chain is seeing such tremendous growth that it is now ramping up its expansion plans. It opened over 100 stores in 2017, 41 of them in the third quarter alone, more openings than it's had during any other quarter ever. The store has about 600 locations.

It admits that new stores typically account for over 80% of its annual growth, but management said that continuously expanding "the store base remains our highest priority."

That's not unlike what's going on at the other dollar stores. For example, Dollar General recently announced it plans to open 900 new stores in 2018. Over the first three quarters of 2017, Dollar Tree had opened more than 460 stores, with plans to open 600 for the year. That one-year tally almost equals Five Below's total number of stores (it has 625 in 32 states), but as the chain recently entered California, management expects a "cluster" development of new stores in the state in the future.

A profitable business model

Despite the accelerated growth, Five Below is still able to maintain a fairly consistent return.

Five Below has grown sales per square foot from $251 in 2012 to $275 over the last 12 months, according to research company eMarketer. In comparison, Dollar General stands at $187 per square foot and Dollar Tree is at $161 per square foot.

The treasure hunt atmosphere of the deep discounters has long been a factor in their success, and few retailers are doing it better than Five Below. With an incredibly attractive price point for the tweens and teens -- its main demographic -- and the ability to take charge of whatever trend is hot, this retailer could be the best in the business.

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Rich Duprey has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Walt Disney. The Motley Fool recommends Five Below. The Motley Fool has a disclosure policy.