Investors should look at valuation multiples when deciding whether to enter or exit stocks. Valuation multiples are driven by perceived growth, risk and uncertainty, and investors’ willingness to pay.
There are various multiples available to evaluate stocks. We are choosing the PE (price-to-earnings) ratio due to the high visibility of Wendy’s Company’s (WEN) earnings. The forward PE ratio is calculated by dividing a company’s current share price by its forecast EPS (earnings per share) for the next 12 months.
Since the beginning of 1Q16, Wendy’s PE multiple has been trading in the range of 25.9x–30.25x. On May 11, 2016, the company’s PE multiple was 27.7x, lower than the midpoint of its quarterly range.
Wendy’s announcement of its 1Q16 results, wherein its management cautioned that its same-store sales growth would be lower than 3%, led to a fall in its share price. This led to a fall in the company’s PE multiple from 29.7x to 27.7x.
The caution expressed by Wendy’s management has led analysts to lower their estimates for the next four quarters, which has led to a fall in investors’ confidence. Although Wendy’s raised its EPS guidance for 2016 from $0.35–$0.37 to a new range of $0.38–$0.40, it failed to impress investors.
Analysts are expecting the EPS for 2016 to be $0.4, which would represent a rise of 14.5% from $0.35 in 2015. The company’s current share price may have already factored in EPS growth for 2016. If its results come in lower, its stock could face selling pressure, which could bring its PE multiple down, and vice versa.
To mitigate company specific risk, you can invest in the Guggenheim S&P 500 Pure Growth ETF (RPG), which has 44% of its investments in restaurants and travel companies.
Next, let’s see what analysts are recommending for Wendy’s after its 1Q16 results.