They have been excellent long-term performers, but the actions of discount retailers Five below (NASDAQ: FIVE) and autonomous vacuum company I robot (NASDAQ: IRBT) are both underperforming market averages so far in 2021. At the time of this writing, Five Below stock is up 9% for the year, but down 20% from report to this year’s summit. For its part, iRobot stock is only up 1% for the year and painfully down 50% from its highs reached in January.
I think these are blips for Five Below and iRobot. At five years or more, I think both stocks will generate better returns than the market average. This means that investors don’t have to wait for better prices. These are good stocks to buy now. Here’s why.
A snowball of cash
For those who don’t know, the concept of Five Below is to sell products to children and teens for under $ 5. While it might sound a little boring, this is a retail chain that has resonated with consumers for years. Since its IPO in 2012, same-store sales have grown every year, except in 2020, when stores were closed due to the coronavirus – but growth has now returned. In addition, the company is solidly profitable with increasing net income at a compound annual growth rate of 16% over the past five years.
There is good reason to believe that Five Below’s profits may continue to rise. The company plans to operate more than 2,500 sites over the long term, up from 1,121 today. To support this growth, it had to build new distribution centers, a slight drag on financial results for now. But its center in Arizona has only become operational in recent weeks, and another in Indiana is expected to open within a year.
Above all, these two new distribution centers can support 2,000 stores. Therefore, Five Below’s profit margins are expected to increase by gaining operational leverage as it grows from 1,121 locations to the 2,000 that its infrastructure can support.
Five Below is a cash-generating business. And right now, the best thing she can do with her cash flow is open up new locations, as she plans to do. Consider that the average business invests $ 300,000 to open a store. But the stores make $ 450,000 in annual profits before interest, taxes, depreciation, and amortization (EBITDA).
This means that new stores pay for themselves in less than a year. And, like a snowball rolling down the slope, they begin to contribute to Five Below’s growing cash flow. This should push up the Five Below stock sooner or later.
An economic model that evolves for the better
iRobot is the market leader in self-contained vacuum cleaners. And to be clear, this is a market that you want to lead. According to Meticulous Research, the robotic vacuum cleaner market could reach $ 15.4 billion by 2028 growing at a compound annual growth rate of 23.2%. Therefore, it stands to reason that iRobot’s business will experience substantial growth over the next seven years.
Besides the growing market opportunity, iRobot is revamping its business plan for the better. He tries to build a direct relationship with the consumer so that he can develop recurring income streams. Recurring revenue can take many different forms, but one of the things the business is experiencing is Robot-as-a-Service. Just pay a monthly fee to get a vacuum, upgrade every three years, and any replaceable accessories needed during that time.
This could potentially smooth iRobot’s revenue – right now, sales can fluctuate significantly from quarter to quarter. Also, once the business gets a loyal subscriber, it may be able to offer other high margin add-on services on time.
To establish this direct relationship with the consumer, iRobot launched its customizable operating software called iRobot Genius. To use the software, consumers must enter an email address, which helps the company build its customer database. In the last quarter, it had 11.6 million connected customers. That’s a 67% year-over-year increase and over 10% since the start of the year. Obviously, the plan is working.
More than that, the iRobot Genius software appears to be a catalyst for better customer satisfaction, a great indicator of the long-term health of this business. Consider that a good Net Promoter Score (NPS) – a widely used measure of customer loyalty – is greater than 1 and a Perfect NPS score is 100. As of June 2020, before the launch of iRobot Genius , the company had an NPS of 25, according to Comparable. The score was good, but not great. Now he has an NPS of 42, a huge leap in customer satisfaction in a very short period of time.
Considering the growing desirability of the market and improving its trading fundamentals, the iRobot stock looks like an absolute theft trading at less than 20 times the profits over time.
Focus on these winners
Stocks that have underperformed the market average often make poor investments. You will hear many investors say things like “Winners win”. This maxim recognizes that a course of action generally follows the performance of the company. And companies that have performed well in the past are excellent candidates to perform well in the future.
With this in mind, investors might be put off by Five Below and iRobot because they underperformed the market in 2021. But nine months is not long enough to judge these stocks; all big long-term winners go through periods of underperformance. When zoomed out, both have been great for long-term investors. For this reason, I think 2021 is just a blow to their long-term growth trajectories.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.