Why I Am Selling Five Below
Reasons, lessons learned, and the bright side
Hi reader,
Five Below (one of the positions in my portfolio) shared pretty important news yesterday, which not only had implications for its financials but also the investment thesis as such. The most important news from the press release was that Joel Anderson is set to leave the CEO position effective immediately. His temporary substitute will be Ken Bull (current COO) and Tom Vellios (co-founder) will transition from his non-executive director position to a position of executive director while the company searches for a new permanent CEO.
The company also lowered its guidance for Q2, which is honestly surprising considering how “derisked” the guidance given in the most recent earnings call was. Turns out it wasn’t derisked and once again surfaced some execution issues. The lowered guidance is obviously not great but nothing thesis breaking if it were to be the only thing that happened. It’s the management shuffle that worries me the most. In this article I’ll share why I am selling Five Below and what I will do from here on out.
The CEO transition is what worries me the most
Five Below has always been sort of an outlier in my portfolio. Everywhere I look in my portfolio I see strong moats and durable businesses, something that might not be entirely applicable to Five Below. This, however, was something that I already knew when I invested in the company, not something that I have just realised.
There’s no denying that retail is a tough space where moats are tough to build due to the somewhat lowish barriers to entry (in many cases) and fast changes in customer perception and tastes. Now, I am not saying that every retail company has a weak moat (this would be demonstrably false); it’s just that it’s tough to build a really durable moat in the industry, especially in the discretionary space.
Two of the things that I alluded to when including Five Below in my portfolio despite its somewhat less-clearer or weaker moat were…
The higher growth would technically serve to compensate for the higher risk (meaning that risk-adjusted returns would still be favourable)
Confidence in the CEO, which helped me build implicit conviction
It’s hard to justify any of these standing true today. I am perfectly aware that lower growth might be a temporary issue. The US low-end consumer seems to be in a dire state and this weakness has not only been felt by Five Below but by many other discretionary retailers. There’s no denying, though, that Five Below is in a much better financial position than many of its peers, meaning that it can perfectly survive a tough period so long it’s temporary. If the weakness is permanent then the financial position will not serve much as a defense mechanism.
It’s point number 2 that worries me the most. A good part of my conviction in the company relied on management, and more specifically, on Joel Anderson. I built my conviction by reading a lot about him and his execution over the years and came out quite impressed. Discretionary retail is undoubtedly an industry where execution matters dearly (ie., it’s not an industry where an idiot can run a company for long), and some execution issues started to surface last quarter. Despite these execution issues, I trusted Joel Anderson to turn things around, but obviously this is not possible anymore after his departure. In just a few words, with Joel Anderson’s departure, my implicit conviction is down substantially.
And I don’t want to be misunderstood, it was probably a mistake on my part to trust Joel Anderson as much as I did. Under his tenure, Five Below experienced excellent growth. However, I start to wonder if a portion of this growth came from favourable conditions over a decade where Five Below did not see any competition coming into its niche. This might be starting to change with the arrival of Temu, similar concepts like pOpshelf from Dollar General, and Amazon’s new offering. Could the recent weakness be driven purely by the macroeconomic environment? 100%, but there’s no denying that the management team exhibited poor foresight and did not run the business optimally through this period. At this point we don’t know who will be the new CEO, but it seems pretty obvious he will come from outside the company, something that I also don’t like.
What I will do with my position
After today’s drop, Five Below seems attractively priced and it seems that not much has to go right for the stock to work, but I have honestly lost conviction in the future of the company. The reality is that the company has gone from a growth story to a turnaround story rather fast, and I don’t like betting on turnarounds. For this reason, I’ll sell my entire position this week.
This doesn’t mean that Five Below is automatically a bad company that can not be successful in the future, just that I prefer to see how things unfold from the sidelines. I will continue monitoring the company to understand how the thesis evolves, although it’s unlikely that I will ever buy a company where the moat is not strong and durable, regardless of the adeptness of the management team. I’ve learned from my mistakes.
I would also like to make clear that I am not selling Five Below because the stock price is going down; I am selling the company because the thesis has changed. Thesis changes are not rare, though. The world changes fast and companies adapt to it. For example, Danaher’s investment thesis has definitely changed through the years, as it has gone from an industrial conglomerate to a healthcare-focused company. The key lies in being able to have conviction and feel comfortable with the new thesis.
Five Below has been quite volatile and I have been reluctant to sell it in the past due to the stock price action because the weakness seemed temporary. This proved to be right on many instances, but the rebound after that weakness also proved temporary, and my mistake was not understanding that the weakness was permanent.
Learning from my mistakes and portfolio discussion
There’s no denying that Five Below has been a terrible investment, not only because I am selling it at a 30%+ loss but because the opportunity cost has been quite significant after having owned it for more than 2 years. Not investing in Five Below would not only have helped me avoid the capital loss, but would’ve probably made me invest that money in a better idea in the portfolio that would’ve probably have returned a capital gain (the six companies that I included in the portfolio before or around the time I included Five Below have produced a capital gain, and sometimes quite significant).
Of course, I won’t beat myself up too much for this mistake. Investing is not a game of getting everything right, and I’d go as far as to say that one of the toughest parts of investing is acknowledging that you’ll be wrong a fair amount of times. The good news is that stock returns are skewed in an investor’s favour, as stocks can only go down 100% but can appreciate considerably more than that. Of course, I expect to point out mistakes before they cost me 100%, but you get me.
I can also look at the bright side, though. One of the best things about investing is that one can learn significantly from mistakes, and the only way to learn from these is to make them. Of course, this doesn’t mean my goal is to make mistakes, but it’s always worth looking at the bright side when they inevitably happen. So, what have I learned from Five Below? Several things…
Discretionary retail is a tough industry, very profitable when you get it right, but risky overall
To never compromise my quality standards: throughout my ownership in Five Below I stated several times that it was the a good company where I had a lot of conviction in management, but that the quality level was lower than that of other companies in my portfolio
If the measurement period is not long enough then attributing past success entirely to the management team can be a mistake. A company might well be living in an ideal scenario and execution problems might surface once the environment changes. The more time you can judge a management team on, the more its success will be more applicable to skill rather than luck (same goes for investing)
The good news is that, despite Five Below clearly being a terrible investment over the last two years, my portfolio is up nicely over this period. The reason is that, on average, portfolio companies have done well. For example, there are currently 4 companies that are either baggers or close to being baggers, with several other companies being up more than 40%. Of course, this does not mean that every company in the portfolio will become a bagger and that there will be no additional mistakes, it simply means that the winners have greatly compensated for the losers (which are inevitable).
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One thing that puzzles me a bit is insider transactions. Despite the company going through a tough period and the management shakeup, the last significant insider transaction was a $500k purchase by Joel Anderson (the now former CEO) at $161.
Conclusion
I hope this article helped you understand why I am selling Five Below. It’s a hard decision but one that I believe I must do due to the thesis shift. The company is capable of executing a turnaround, but I prefer to monitor the company from the sidelines for the time being and see how things evolve.
In the meantime, keep growing!
Disclaimer: As of the moment of this writing, the author might have positions in the securities discussed. The article is intended with information purposes only, do your own due diligence.
Tough decision, but if your conviction isn't there anymore it is the only right decision.
Any ideas on where you will allocate the capital? Existing position or looking for something new?
I see! Keep up with the good work.