Valuation multiples help investors to decide on entry and exit points in securities. A company’s valuation multiple is affected by its perceived growth, risks and uncertainties, and investors’ willingness to pay.
Forward EV-to-sales ratio
Various multiples can be used to determine stocks’ valuations. We’re using an EV-to-sales (enterprise value to sales) ratio, as three of the eight companies under review are still in the growth phases of their life cycles. During the growth phase, a company’s operating costs will be higher, and its EPS (earnings per share) can’t be considered for valuation.
A company’s forward EV-to-sales ratio is calculated by dividing its current EV by its sales forecast for the next 12 months. Estimated future sales give more visibility to a company’s growth prospects.
On May 19, 2016, the fast casual restaurants under review were trading at a median forward EV-to-sales multiple of 1.5x.
Since going public in January 2015, Shake Shack’s (SHAK) valuation multiple has been trading in the range of 18.3x–4.8x. As of May 19, SHAK was trading at its lowest multiple of 4.8x.
Though better-than-expected 1Q16 results pushed SHAK’s price up, its EV-to-sales fell as analysts increased their revenue estimates for the company for the next four quarters.
SHAK was followed by Chipotle Mexican Grill (CMG) with a valuation of 2.9x. Under the dark cloud of food safety issues that struck the company in October 2015, it has continued to struggle. This has led to a fall in its share price as well as its valuation multiple. Investors are still skeptical about the immediate revival of Chipotle.
Panera Bread (PNRA), which posted strong 1Q16 results, was trading at 1.8x, close to its peak of 1.9x as of the beginning of 2016. During the same period, Habit Grill (HABT) and Fiesta Restaurant Group (FRGI) were trading at valuation multiples of 1.5x and 0.93x, respectively.
Noodles & Company’s (NDLS) aggressive expansion led to a fall in its operating margins, which eroded investor confidence. NDLS was trading at a valuation of 0.65x. Potbelly (PBPB), which showed improvements in its margins in 1Q16, was still trading at a lower valuation multiple of 0.7x.