What are investors cheering about?
We believe that the unit growth and high average unit volume is already priced into Shake Shack (SHAK) stock. Shake Shack reported 11.7% comps growth in the most recent quarter and 7.2% in the previous quarter. This is the story investors seem to be cheering. Shake Shack may have a higher comp sale potential, but given that most of it has so far come from price increases, investors need to be cautious.
As Shake Shack develops more restaurants, the company will add revenue from each new restaurant. But how much future growth can be expected, and what price should investors pay for that growth?
In the chart above, we have compared the valuation multiple forward EV (enterprise value)-to-revenue to the revenue growth potential of some of the best retailers with strong brands in the US. Forward EV-to-revenue is currently more meaningful in Shake Shack’s case. As the company grows, it will achieve operating leverage and allow fixed costs to spread out.
Analysts expect revenue growth of around 20.6% per year at the moment, based on the firm’s unit growth and same-store sales growth expectations. As plotted in the chart above, you can see that the Shake Shack EV-to-revenue multiple is 18.5x. This is much higher than those of its peers, including Chipotle (CMG).
CMG makes up 1% of the Consumer Discretionary Select Sector SPDR Fund (XLY).
Is a pullback around the corner?
Shake Shack’s current valuation suggests investors are willing to pay a high premium for the company’s growth prospects and that the risk of investing in Shake Shack is very low. But should investors be paying a high premium for the company’s high growth? When compared to its peers, Shake Shack seems overvalued.
There may still be some room for traders to wiggle out some profits from the momentum, but long-term investors need to be cautious. The company is expected to release its next earnings report on August 13, 2015. We’ll update our analysis, so make sure to check back then.