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What Will Stop the Decline of Shake Shack’s EV-to-Sales Multiple?

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Valuation multiple

Valuation multiple helps investors decide whether to enter or exit a stock. A company’s valuation multiple is affected by its perceived growth, risk and uncertainties, and investors’ willingness to pay.

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EV-to-sales ratio

There are various multiples available. We’re using an EV (enterprise value)-to-sales ratio, as Shake Shack (SHAK) is still in the growth phase of its life cycle. During the growth phase, companies’ operating costs will be higher, and EPS can’t be consided for the valuation. So we use the forward EV-to-sales ratio, which is calculated by dividing current enterprise value with forecast sales for the next 12 months. Estimated future sales give more visibility to a company’s growth prospects.

SHAK’s EV-to-sales multiple

Since its listing in January 2015, Shake Shack’s (SHAK) EV-to-sales multiple has been trading at 4.7x–18.5x. After listing, investor euphoria about the company’s growth prospects and expectations of future returns pushed SHAK stock up. The company’s share price peaked at $96.80 on May 22, 2015. This increased its EV, which in turn pushed the EV-to-sales multiple up. Since then, share prices have fallen as investors grew skeptical of the future growth prospects of the company, which also brought the multiple down.

As of February 22, 2016, SHAK was trading at an EV-to-sales multiple of 5.6x, closer to the low point. Being a nascent company, SHAK maintains a high valuation multiple compared to the median of peers such as Chipotle Mexican Grill (CMG), Panera Bread (PNRA), and Jack in the Box (JACK).

Uncertainties or risks

SHAK’s current share price may already have factored in future estimated sales of $222.6 million for the next 12 months. That represents a growth of 27.7% from the corresponding previous year’s quarter sales of $174.3 million. If 4Q15 results come in lower, then SHAK stock could face selling pressure, which could bring the EV-to-sales multiple down, and vice versa.

You can mitigate these company-specific risks by investing in the iShares Russell 2000 Growth ETF (IWO), which has 0.03% of its portfolio invested in SHAK.

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