Investors should look at valuation multiples when deciding whether to enter or exit a stock. Valuation multiples are driven by perceived growth, risk and uncertainties, and investors’ willingness to pay for a stock. There are various multiples used to evaluate a stock. In this part, we’ll use the PE (price-to-earnings) multiple due to its high visibility in Papa John’s (PZZA) earnings. The forward PE multiple is calculated by dividing the current share price by the forecast EPS (earnings per share) for the next 12 months.
Since the beginning of 1Q16, Papa John’s PE multiple has been trading at 19.1x–25.8x. As of April 25, 2016, the company was trading at 23.6x. During the same period, Papa John’s peers Yum! Brands (YUM), Starbucks (SBUX), and Domino’s Pizza (DPZ) were trading at 21.8x, 28.1x, and 30.1x, respectively.
Investors were concerned about the increase in minimum wages. This could squeeze Papa John’s margins. Papa John’s PE multiple fell in January 2016. However, better-than-expected 4Q15 results increased investors’ confidence. This hiked the PE multiple.
Risks and uncertainties
With better-than-expected 4Q15 results, investors are expecting the momentum to continue in 1Q16 as well. Also, the company is trying to improve its same-store sales growth by providing clean and healthier pizza. The company removed artificial ingredients from its menu. It started using poultry that’s free of human and animal antibiotics. The poultry is fed a 100% vegetarian diet. If the move towards cleaner and healthier ingredients fails to generate the expected same-store sales growth, the increase in commodity prices could reduce the company’s margins. This would cause the EPS to fall.
Papa John’s current share prices might have factored in the estimated EPS of $2.40 for fiscal 2016. It represents growth of 13.5% from 2015. If the company fails to meet these expectations, then the stock could face selling pressure. This could bring its PE multiple down. You can mitigate these company-specific risks by investing in the Guggenheim S&P 500 Pure Growth ETF (RPG). RPG has 44% of its holdings invested in restaurants and travel companies.
In the final part of this series, we’ll look at analysts’ recommendations for Papa John’s before its 1Q16 earnings.