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.
PZZA’s PE multiple
Since the beginning of 2016, Papa John’s PE multiple has been trading in the range of 19.1x to 25.8x. Better-than-expected 1Q16 results hiked its PE multiple from 22.8x to 24.9x. During the same period, Papa John’s peers Domino’s Pizza (DPZ), YUM! Brands (YUM), and Starbucks (SBUX) were trading at 28.1x, 21.6x, and 27.4x, respectively.
Cleaning up the menu
Papa John’s initiative to remove all artificial and synthetic ingredients from its menu, as well as measures such as using of 100% vegetarian poultry feed, appears to have increased investors’ confidence. Despite analysts lowering their 2Q16 EPS and SSSG estimates, the share price rose. This indicates that investors are more confident about Papa John’s growth prospects than analysts are.
Over the next four quarters, analysts are expecting Papa John’s (PZZA) to post EPS of $2.40, which represents a growth of 8.3% from the corresponding quarters of the previous year.
If the company’s results come in lower, the stock could face selling pressure. That could bring the PE ratio down and vice versa. You can mitigate these company-specific risks by investing in the Guggenheim S&P 500 Pure Growth ETF (RPG). It invested 44% of its investments in restaurants and travel companies.
In the final part of this series, we’ll see what analysts are recommending for Papa John’s after its 1Q16 results.