Hi reader,
Five Below reported terrible Q1 earnings yesterday, and there’s no sugar-coating it. I have grown increasingly wary about retail as a profitable hunting ground, although it undeniably offers attractive investment opportunities. The thing is that you can make a lot of money in the retail industry by investing in a repeatable and profitable model, but the long-term survival of these kinds of repeatable models is more the exception than the norm in the industry.
The structure of this article will be somewhat different from what I usually do. I’ll start by reflecting on my investment in Five Below. I’ll then share the summary table, discuss the numbers, and discuss “the good, the bad, and the ugly.” Finally, I’ll review the company’s valuation, what I will do from my position, and what I believe is the most probable scenario going forward.
Some reflections on my investment in Five Below
I added Five Below to my portfolio on April 13, 2022, building my position over time and taking advantage of the stock’s volatility to end up with an average cost of $147 per share. This means I am currently down around 10% on my position, and if the pre-market earnings drop holds, I’ll be down around 30%. There’s no denying that Five Below has been a pretty terrible investment for me thus far.
When judging the merit of any investment, we should look not just at our total return but also at the time frame in which we achieved it. Combining both variables will ultimately allow us to benchmark it and understand if we made a good decision.
My investment in Five Below has not been bad (thus far) just because it’s down 30%. At the end of the day, that’s a manageable unrealized loss, especially since I hold other positions that compensate for this loss many times over. The worst thing about my investment in Five Below has been opportunity cost. It’s not only that I am down 30% on my position, but that I could’ve reinvested that money in other portfolio companies that have fared much better since then (obviously, this is easy to spot in hindsight). This means that the actual economic loss is not the one we see in the -30% but rather the -30% combined with what I could’ve made in another investment. The interesting thing about investing is that our P&L doesn’t directly reflect our mistakes because opportunity cost and omission errors are entirely absent but are real costs for investors.
As I’ve discussed in many other articles, as a long-term investor aware of his inability to time the cycle, I know that I will be exposed to this opportunity cost. This has several implications depending on how things go. If I make a mistake with the company and end up realizing it and selling it at a loss, then I will end up suffering a realized loss amplified by the unrealized loss (or, better said, forfeited gain) created by the opportunity cost. If I am right about the company, then the opportunity cost’s impact on returns should diminish as years go by. The good news for individual investors here is that, as you don’t need to prove anything to anyone in any given year, you can freely choose to be exposed to opportunity costs. This is not the case for many investment professionals who feel pressured to deliver year after year.
The key question is:
In which bucket does Five Below belong?
Well, I think it’s still too soon to know, but I’ll share some of my thoughts in the remainder of the article.
The rest of the article is reserved for paid subscribers. I launched the paid subscription yesterday. There’s an on-going offer limited to the first 25 subscribers (we are not far from this number), through which you can lock-in a 25% forever discount on any plan:
As announced in the article I link above, as a free subscriber you’ll still get free content from time to time, just as it has been the case since I brought Best Anchor Stocks to Substack.
Many people have asked me if there’s any sort of “model” research they can look at to judge the quality of the research. This is a great question and is precisely the reason why I recently published my deep dive on Deere. You can read by clicking the following button (it’s close to becoming the most-read article of the entire site):
I’d also recommend reading the rest of the articles I have published for free, as they’ll help you grasp the type of content you can expect.