LOUIS LLANES: Hi, this is Louis Llanes with Wealth Net Investments for Real Vision Tech Trader. Today I'm going to be talking about a company called Five Below. Five Below is a very interesting company. They're a lot like a Dollar General or Dollar Tree, except for one very, very important difference-- they target teens and preteens with their product lines. And that is giving them an edge in the market. They're growing fast. And they also have strong returns on capital.
So what I want to talk about a little bit is the fundamental backdrop first, and then let's dive into the technicals. When you look at the fundamentals, what I like about this particular opportunity is they have a differentiated concept. There's really no company that's delivering a retail experience like this for the teen or pre-teen. It's $5 or below from almost all their products. So parents, when they go in, they know what they're going to spend. Their average ticket price is about $15 every time they walk in.
And what's really interesting is they're trend focused and their actual market love their product lines. You could see this by looking at the Instagram feeds and the other social media feeds. Their market loves their products. In fact, I had my daughter, who is 12-- she's not quite a teen yet. I had her do some primary research for me and go online and look at these things. And she's like, wow dad, I want to go to one. And I live in Denver. We don't have them here yet. But if we do get them here, I guarantee you we will be there.
So what I like about this company is they have a nimble supply chain. They have a situation where they're monitoring the trends and they're delivering the trends that are working. It's almost like trend following. They're looking at the trends, and whatever is working, they do more of it. And they want to see that networking effect because, you know, teens and preteens, they talk to each other. And when they do that, that creates referrals and generated business that's exponential.
And that's what we're seeing. The company is growing at 29% on a top line basis. And we're seeing return on capitals of 18%. In fact, what's interesting is the company actually gets a payback period of less than one year. And what that means is if they invest in a store, in general, on average, they get their money back before the year is up. And that is not something you can say for a lot of retailers.
So strong return on capitals, good margins. Their margins are about 12%. If you look at Dollar General, their margins are 9%. So there's a lot of reasons to like this company. The company is trading at a very high valuation. But the trends look very, very strong. So if they can keep this growth rate up, they have 750 stores now, they're looking to get to 2,500 stores. With that kind of compounding, you could see this stock trade at much higher levels.
But it is a very aggressive stock and you have to trade it aggressively in order to make money in it. And full disclosure, I bought a little bit more of the stock today and we own the stock in our proprietary accounts. And they do have an advantage over other digital marketers if you think about it. Because they're pricing $5 or below, it's difficult for Amazon and other digital providers to sell economically because they have those high shipping costs and that eats into their margin. So that gives this particular company an edge with these priced items.
They also have very strong expansion. And I would say this is one of the key reasons why I like this, because they have 750 stores now. And they're targeting to grow to 2,500 stores. And that's a very high compounded rate. So I see a lot of growth potential there. The other reason I like this is that the company has a very strong management team. And they've really shown and demonstrated that they can grow the company, which is not always easy to do for the retailing business. They've actually shown that they can take 82 stores and grow them to 750 stores pretty quickly from 2008 to 2018.
They're also very profitable. They have strong margins at 12%. They have good returns on capital. They're earning about 18% return on capital. That's been the average between 2015 and 2018. Now, the other thing I like about this opportunity is their earnings are growing at about 29%. And that's what we're expecting here. And a management team has been guiding at about $3 to $3.07 a share in earnings per share for 2019. We think that's really conservative and other analysts think that, as well.
So we're looking at more like $3.15 on the year, especially if they're able to keep this particular trend up and their margins up where they have been. The other thing we like is that they have really good independent board members. They have eight of the 10 board members are independent. And that really supports a management accountability, which is really important for a publicly traded company. So we like that, as well.
So now I want to dive into the charts. Let's talk a little bit about how to trade this in the technicals. What we have here in front of us is a long-term chart. This is a monthly chart that's going back to really since the company came public. And what you see is the stock started off and it really rose very strong. And then it went into this huge long distribution phase where it just went sideways, up and down. It went to 55% and then it came down to 29% and it came back up near that same $55 level, came back down.
And it really made no price progress all throughout 2014, '15, '16. But then it became clear that the company was able to scale and able to grow this thing and that it was being accepted in the marketplace. And that's when we saw the relative strength turn around. And you can see here this bottom green line is the relative strength line compared to the S&P 500.
And when that line is rising, that's saying that the stock is outperforming the market. And we saw that that started to outperform here back in 2017. And it broke out into new highs in relative strength as the stock broke out of this long period of malaise. And since that time, we've been in a bull phase in this particular stock. Recently, it hit a high of 136. And then it went into a consolidation phase. And you can see it's been months that we had that consolidation.
We have 1, 2, 3, 4, 5, 6, 7, 8 months to the breakout. And now we have a pullback. And that's the key with this particular trade. Now, I want to go and dive a little bit deeper in this particular consolidation phase that we're in right now. So now I want to dive into the current base and look at it more clearly. We have a weekly chart here in front of us. And what I have here is a market profile graph. And the market profile, what it does, that analysis basically takes a look at where the volume has taken place. Where has the stock been trading at? And do we have buying interest and selling interest?
And there's a key concept with market profile, and that is the point of control. And that is really where most of the volume interest has been occurring, at what price level. And you can see that that level is at 117 spot 40. So about $117 a share, that's the point of control during this consolidation phase. So when a stock is in bull mode, in general the stock price will stay above that level. And you know, buyers that like the stock will support the stock around that level, as well.
The other thing that we're looking at is the anchored volume weighted average price. And what that is is that's looking at a similar type analysis as market profile, but it's actually anchored to a low or a high, or some event. And what I have is I have that anchored to the low in this base. And why do we do that? Because we want to know from that low as the buying interest has come in where has the stock been supported at? And you can see the stock came down and it came right to that volume weighted average price, and then it rallied up.
And now we're approaching that volume weighted average price again. And since we have strong fundamentals and a strong relatives trend based on the market-- you can see the relative strength line is moving higher, even though we're going in a consolidation phase, it's still outperforming the market-- that is giving us the ability to understand that if this trend stays in place, strong fundamental backdrop, strong constructive action, then this stock should be supported around that level, around the VWAP, around the support levels that we see.
And if you look at it from a traditional standpoint, most technicians will look at highs and look at that as being a resistance point. And if you breakout through that and it comes down to it, that's considered what's called role reversal support. And that just means that there's buying interest there.
And what we see is we have a range between 125 and 136. So that level combined with the market profile and the volume weighted average price, that gives us a good indication that we're near some levels that we should see. If this stock is still in bull mode, we should see a good entry point.
So that's what we call a mean reversion trade. Now, what I'm looking for this stock to do is I'm looking for this stock to be purchased right around this area right between 128, 125, right around that area. And to really hold that stock up to a rally to 185. We think that stock could go up to 185 based on the fundamental analysis growth rates, as well as a measured move in the volatility of the instrument. We kind of blend those analysis together to come to a probability of what is a likely upside target.
And that upside target, in our view, is 185. So if we have a stock at 125, it goes up to 185, that gives us the 60 points, that's a 50.63% return if we are right on this thing. We're looking at this to be a longer-term trade, six months to a year, and even beyond that, because the stores are growing at a rapid rate and it could go for quite a while. As long as they can stay on their growth trend, we could have a lot of growth in this thing.
So I'm looking at the stock. We have to protect ourself with a company like this, because this particular company, as well with any company we want to protect ourselves. But in particular with a growth company like this, they're very vulnerable to big declines if you have any hiccup in the growth rate. So we want to protect ourselves from that.
Now, what we're looking at is a volatility adjustment. Based on our time horizon, we're looking at a stop at 112, so $112 a share. That gives us $13 of risk to the downside. And if you look at it from a perspective of reward risk, we have 60 to the upside, 13 to the downside. That's 4.62% reward risk. Now, one of the things I wanted to point out is on this bottom line here, this is the APR, the Average Percent Range.
And what we're seeing is the volatility, the average percent range is actually declining. And we like to see that as a basis completing, because generally when you start the new move, you know, volatility tends to decline during that phase. But one of the things that's interesting about this is that if you pull back from a long term perspective, we want to put the odds in our favor. And one of the things that we do is we have a set of score carding on relative the trend and on momentum.
These scores are based on quantitative analysis that lean the probabilities in our favor that a stock can move higher relative to the market. If we have a score of 3 or greater on these, they in general, statistically, the stocks tend to outperform over the next 6 to 12 months. And what we're looking at with the score on 5 below is our proprietary relative strength score is 4. That's very bullish. It's not the highest rating, but it's very bullish.
So relative to the market, if you look at all the opportunities out there, this stock is one of the better ones. And from a momentum perspective, we look at various time frames of momentum and blend them together. The momentum is a 5. So in this market, if you want to be following where the trends are, five below is one of those stocks that you definitely want to be keeping an eye on.
And as you can see, we're pulling back down. And that could be-- in a market where you have a lot of different mean reversion type trades, that could be a time to enter in. So one of the things that is probably the biggest risk that we see is that the market has recently started to crack. There's lots of levels that many technicians have been looking at-- the 200 day moving average, et cetera-- that have been violated. So we saw a 600 point decline in the market and that has gotten a lot of people worried about, hey, maybe all of these stocks are going to be start heading down.
If you're in that camp, one way that you could trade this is that you can actually hedge. But first I want to talk a little bit about the market. Before I get into the hedging, I want to give you a little bit of an idea about what we're seeing in the market. So we talked about the anchored volume weighted average price in the overall stock market. What we're looking at here is the S&P 500 SPDR ETF. It's a great benchmark to look at as a proxy for the market.
And again, we have this volume weighted average price from the low of the base. And what we see is we have support at around 2749. If you look at the other prior low that was in March, that was at 2868. That was violated. It came down through it and I was looking for a bounce in it. And we did have a bounce. But then it immediately failed on talks about China and tariffs.
My personal view is that that is not going to be enough to move the needle to bring the market down to a bear immediately. So that's my personal view on this. But let's say you're not in that camp and you think things are going to be heading down. What you could do is something very, very interesting. You could do a hedged long position. One beautiful thing is there's a lot of innovation in the markets. And we're seeing some new products coming down that really are trading well.
One that I like is the S&P 500 futures contract that are in the micro contracts. So now we have a micro contract that is trading very well, very liquid. I've been trading it and I've had very good success in trading it. The ticker on that is MES and you can look at the June futures contract right now. If we look at that right now, the notional value of that-- so basically the value of one contract-- is 5 times the index.
So if you take 5 times the index right now-- the index is right at 2805 right now-- that's a value of stock that you're moving around of about $14,000. So you can hedge $14,000 increments by just using one particular contract. And you can scale it to your portfolio size and then you can buy Five. So how many shares should you buy of Five?
Well, one of the ways I like to do this is I have kind of a proprietary way of doing it. It's based on how normally people hedge, except they use a little bit of a different change. Instead of using a typical beta calculation, I calculated a modified beta based on the APR, the Average Percent Range. So basically we want to take the average percent range of 5 below and compare that to the average percent range of the market itself, the S&P 500.
And so if you divide those numbers, that'll tell you basically how much more volatile 5 is relative to the market. And so the APR for five is 3.31%. The APR of the stock market is 1.17%. And then we make an adjustment and we multiply that times a correlation factor and we're estimating that correlation at 0.43. So if you multiply that times that ratio, that gives us an adjusted beta of 1.22. OK, so that was a lot of numbers I talked about. But basically what's that saying is that this stock is 22% more volatile than the market. So we need to size it so that we can actually know how many shares to buy relative to one contract for the MES futures contract.
And if you do the math right now, that comes out to 91 shares. So you could short one MES contract, one S&P futures contract, micro contract, and buy 91 shares, and that would be one unit, if you will, of a hedged position. And you could just scale that to your portfolio. If you want to hedge a little bit lighter, you could do a partial hedge. But I wanted to give you the idea of one of the ways that we do this in our proprietary account when we want to deal with market risks.
And the MES has proven to be a great little contract, because if you look at the big contract, sometimes you can't scale it right to your stock position. And with this micro contract, which is very new, but so far it is trading very liquid and very close to the big contract. So I like the way it's trading. I think that's a good way to go if you're worried about the market. So now let's talk a little bit about the risks.
Some of the risks that we see with this particular trade is that there's low switching costs. So other providers can jump into this market. So far, they've proven that they are doing a good job at it and no one's really kind of knocked on their door in a way where they're going to threaten them hugely. Another thing is discretionary spending. Discretionary spending, as with any stock in this space, if we have a recession, you know, this is not a recession proof stock.
So you want to keep that in mind. Another really important thing is that young buyers, their attention could be fleeting. They don't always stay focused on the same thing. If the