[Note: Costco fiscal year ends in August]
We believe that Five Below’s stock (NASDAQ: FIVE) is currently better valued than Costco’s stock (NASDAQ: COST). Costco’s current price-to-EBIT ratio of 29x is higher than levels of 20x for Five Below. So does this gap in valuation make sense? We don’t think so, especially if we look at the fundamentals. More specifically, we arrive at our conclusion by looking at historical trends in revenues and operating income for these companies. Our dashboard Better Bet Than COST: Pay Less To Get More From FIVE has more details – parts of which are summarized below.
1. Revenue Growth
In today’s inflationary environment, consumers are undoubtedly trying to stretch their budgets and seek out value above all else. With this in mind, it’s no surprise that businesses like Costco and Five Below become attractive to investors. Let’s compare the revenues for both companies. Costco’s Revenue grew at an average rate of 12% over the last three years as compared to Five Below’s Revenue growth of 23%. And, if we look at the revenue growth over the last twelve-month period – Five Below’s 23% revenue growth was again higher than the 17% growth for Costco’s revenues.
- Costco is a warehouse club operator. The company collects fees from its members and sells items in bulk at rock-bottom prices while making most of its operating margin from these membership fees. In its fiscal third quarter (ended May 8), Costco generated net sales of $51.6 billion up 16.3% year-over-year (y-o-y). When compared with Costco’s compound annual growth rate of 8.2% in the past decade, its most recent quarter’s growth rate of 16.3% is quite impressive. The company’s Q3 sales were fueled by an increase in shopping frequency of 5.6% and a rise in average transaction total of 7.6%. Also, Costco’s membership households grew to 64.4 million, up 6% higher than last year in FYQ3. Additionally, its renewal rate in the U.S. grew to 92.3% and stood at 90% worldwide – displaying the retailer’s ability to maintain and attract new customers to its warehouses.
- Five Below is a teen-focused discount retail company. Sales in the latest quarter (ended April 30) increased 7% y-o-y to $639.6 million. Although this was a huge slowdown from previous quarters, it was still on top of a nearly 200% revenue surge in the year-ago period. Management recently laid out its long-term outlook, revealing that Five Below still has a lot of growth potential ahead. By 2025, the plan is to double sales and earnings per share. And by 2030, management hopes to more than triple the store footprint to 3,500, compared to 1,225 as of April 30.
2. Operating Income Growth
Five Below’s operating income growth also compares favorably when compared to Costco in the last twelve months and the last three year period. Better revenue growth for the former led to higher operating income.
The Net of It All
Five Below has seen higher growth in revenues and operating income than Costco in the last twelve months and three years. Yet, it has a comparatively lower price-to-EBIT ratio when compared to Costco. This comparative underperformance in Costco’s revenue and operating income growth compared to Five Below reinforces our conclusion that COST stock is expensive compared to FIVE. We think this gap in valuation will eventually narrow over time to favor the less expensive name.
It is also helpful to see how its peers stack up. Check out how Costco’s Peers fare on metrics that matter. You will find other valuable comparisons for companies across industries at Peer Comparisons.
With inflation rising and the Fed raising interest rates, Costco has fallen 8% this year. Can it drop more? See how low can COST stock go by comparing its decline in previous market crashes. Here is a performance summary of all stocks in previous market crashes.
|S&P 500 Return||-3%||-16%||78%|
|Trefis Multi-Strategy Portfolio||-4%||-17%||234%|
 Month-to-date and year-to-date as of 8/31/2022
 Cumulative total returns since the end of 2016