August 25, 2017

FIVE’s Uniform Adjusted EPS’ is greater than as-reported earnings suggest, and forecasted to continue growing, making the name ripe for a short squeeze


  • FIVE’s profitability is materially distorted by accounting for operating lease expense
  • As such, their UAFRS EPS’ is expected to be $0.33 in Q2 and $2.02 in the next year, not $0.26 and $1.68, respectively, as GAAP accounting metrics report
  • At current valuations, markets are embedding expectations for 14% EPS’ growth annually, which is in line with adjusted projections for 14% annual EPS’ growth, warranting equity upside should the firm beat estimates
  • With almost 15% of the firm’s outstanding shares being held short, the potential for a short-squeeze is high, elevating risk for short-sellers

 

Five Below, Inc. (FIVE) is expected to release Q2 2018 GAAP EPS of $0.26 on 8/30, which would represent 44% growth relative to EPS of $0.18 in the same period last year. Moreover, full-year estimates are bullish, with projections for EPS to improve by 26% in the next four quarters, from $1.33 in the four-quarter period ended Q1 2018, to $1.68. Despite this bullish outlook, shares have fallen over 7% from their 52 week high, as investors have become wary of seemingly aggressive valuations, and shorts have piled in, with short interest approaching 15% recently.

However, after making the appropriate adjustments under Uniform Adjusted Financial Reporting Standards (UAFRS), it is apparent that profitability is greater than traditional EPS implies, and is expected to continue to grow going forward.

Specifically, under UAFRS, Uniform EPS (EPS’) is actually expected to be $0.33 in Q2, a 26% increase from $0.26 in the same period last year, and is also expected to grow by 21% in the next four quarters, following 18% growth in the four-quarter period ended Q1 2018. EPS’ is expected to reach $2.02 in the next year, a solid improvement from $1.67 in the last year, and 20% greater than the EPS levels that GAAP accounting metrics report. This suggests that valuations are less aggressive than they seem at first glance, and FIVE may actually be fairly valued.

The quarterly results show a similar trend, with EPS’ expected to remain above as-reported EPS going forward with substantial growth, and, should EPS’ continue to grow as it is expected to, this suggests valuations may not be as expensive as they first appear.

UAFRS, Uniform Adjusted Financial Reporting Standards, call for the removal of distortions from issues like the treatment of operating lease expense. Once removed, it is apparent that FIVE’s profitability is greater than as-reported metrics suggest, which can have material implications for shares at current valuations.

UAFRS vs. As-Reported EPS

Investors make major decisions about which companies to own based on quarterly company earnings, the most common metric mentioned in traditional corporate investment analysis.

However, more often than not, the earnings that companies report in any given quarter can swing wildly and lead investors to completely wrong conclusions, because GAAP and IFRS rules force management to report results in ways that are not representative of the real operating performance of the business.

While there is a case to be made that some management teams can use “creative accounting” to adjust numbers, the research would show that more often than not, the real problem is with the accounting rules themselves, not management’s use of them.

The UAFRS Advisory Council has identified over 130 accounting and financial reporting inconsistencies (some of which can be found here), of which several have a material impact on FIVE’s financials.

Impact of Adjustments from GAAP to UAFRS

One key UAFRS adjustment has the largest impact on FIVE’s income statement, to get from earnings to UAFRS-adjusted earnings. This is related to operating lease expense.

FIVE has had consistent, material operating leases each year. The decision management makes between investing in capex and investing in a lease is not a decision between an expense and an investment, but rather a decision in how management wants to finance their investments. If they would rather spend cash up front for the asset, they will spend capex. However, if they want to spread the cost of the asset over several years, they will instead choose to lease the asset. That said, as-reported accounting statements treat one as an investment, and the other as an expense that does not impact the balance sheet.

UAFRS-reporting adjusts for this traditional accounting distortion by treating all operating leases as investing cash flows. This simple reclassification removes a tremendous amount of accounting noise related to investment activities and improves investors understanding of the operating earnings of a business.

Greater-than-reported EPS’ and forecasts for growth suggest valuations may be less expensive than they appear

At current prices, FIVE is trading at a 28.4x traditional forward P/E (Fwd V/E’), which at first glance may appear rather expensive relative to the firm’s competitors. However, after making the requisite adjustments, it is apparent that the firm is actually trading at a UAFRS-based P/E of 25.6x, which is actually in line with valuations for peers with similar growth prospects.

When considering the fact that EPS’ is expected to continue to grow at double-digit levels going forward, valuations are less aggressive than they appear. At a 25.6x UAFRS-based P/E (Fwd V/E’), markets are embedding expectations for annual EPS’ growth of 14%, which is in line with UAFRS-based long-term adjusted analyst estimates for 14% annual EPS’ growth. As such, equity appears fairly valued, and, should FIVE outperform analyst estimates, a short-squeeze could quickly materialize.

By using Uniform Adjusted Financial Reporting Standards (UAFRS), investors see a cleaner picture that distorted GAAP and IFRS metrics cannot show. By standardizing financial reporting consistently across time and across companies, corporate performance and valuation metrics improve dramatically. Comparability of a company’s earnings over time, trends in corporate profitability and comparability in earnings power and earnings growth across close competitors and different sectors becomes far more relevant and reliable.

To find out more about Five Below, Inc. and how their performance and market expectations compare to peers, click here to access the open beta of the Valens Research database.

Our Chief Investment Strategist, Joel Litman, chairs the Valens Research Committee, which is responsible for this article. Professor Litman is regarded globally for his expertise in financial statement analysis, fundamental research, and particularly Uniform Accounting, UAFRS.