A valuation multiple helps investors to decide whether to enter or exit a stock. A company’s valuation multiple is affected by its perceived growth, risk and uncertainty, and investors’ willingness to pay.
There are various multiples available for valuing a stock. We’re using an EV-to-sales (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 are higher, and EPS (earnings per share) can’t be considered for valuation purposes.
The EV-to-sales ratio is calculated by dividing a company’s current enterprise value with its 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 EV-to-sales multiple has been trading at 4.7x–18.5x. Investor euphoria about the company’s growth prospects and expectations of future returns pushed SHAK’s stock up.
The company’s share price peaked at $96.80 on May 22, 2015. This increased its EV, which in turn pushed its EV-to-sales multiple up. Since then, share prices have fallen as investors have grown skeptical about the company’s future growth prospects. This has also caused its EV-to-sales multiple to fall.
Although SHAK’s strong 1Q16 results raised its share price, its EV-to-sales multiple fell from 4.9x to 4.7x. This fall in valuation was due to a rise in revenue estimates for the next four months. Analysts have increased their revenue estimates for the next four quarters from $254.3 million to $263.9 million.
During the same period, SHAK’s peers Panera Bread (PNRA), Chipotle Mexican Grill (CMG), and Jack in the Box (JACK) were trading at 3x, 1.8x, and 2.1x, respectively. As SHAK is in the growth phase of its life cycle, it enjoys a higher valuation multiple compared to its peers.
SHAK’s current share price may have already factored in future estimated sales of $263.9 million for the next 12 months. This represents a rise of 27.5% from $207 million in the corresponding quarters of the previous year.
If SHAK’s results are lower than estimates, its stock could face selling pressure. This could bring its EV-to-sales multiple down, and vice versa. 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 in restaurant and travel companies.
In the next article, we’ll see what analysts are recommending for SHAK following its 1Q16 results.