Since coming public in late 2012, shares of discount retailer Five Below Inc (FIVE) have moved higher by more than 40%. However, there are three reasons why investors should avoid buying shares in FIVE.
Dollar Stores Struggling
As shown by the chart below, shares of the leading dollar stores, Family Dollar (FDO), Dollar General (DG), and Dollar Tree (DLTR) have all moved lower while FIVE has moved sharply higher. To me, this is a major warning sign because FIVE targets the same consumers that the dollar stores do. If the dollar stores are having problems then it seems likely that FIVE could soon face the same fate. Just as Wal-Mart has proved problematic for dollar stores, I would expect FIVE to be negatively impacted by Wal-Mart as well.
Currently, FIVE is trading at more than 50 times forward earnings. At this valuation, if FIVE fails to meet earnings expectations, shares will plunge. Even if FIVE reports strong earnings going forward, I am of the opinion that the current valuation has already priced in positive results.
Recently, there has been a great deal of insider selling in FIVE. Of course, this does not come as a complete surprise since it is somewhat normal for insiders to sell soon after a company goes public. Nonetheless, the insider selling is a negative as it indicates that those who know the company best believe that the stock has peaked.
Don't Sell It Short
Despite my negative view of FIVE, I would not sell it short. Currently, short interest in FIVE stands at 3 million shares or 14.8% of the float. This indicates that many market participants, like me, are skeptical about the future for FIVE. However, this means that if FIVE continues to move higher and report strong results a short squeeze is possible. Given this possibility, I would avoid selling FIVE short.
The recent sell-off in dollar store stocks, expensive valuation, and high level of insider selling are all reasons to avoid FIVE. That being said, the high short interest means that a squeeze higher is possible given the right circumstances. Due to this, despite my negative outlook for FIVE, I would not sell it short.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.