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Can 2Q16 Results Drive Shake Shack’s Valuation Multiple Up?

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Valuation multiple

The valuation multiple helps investors decide whether to enter or exit a stock. A company’s valuation multiple is affected by its perceived growth, risk and uncertainties, and investors’ willingness to pay.

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EV-to-sales ratio

There are various multiples available, but we’ll use an enterprise value-to-sales, or EV-to-sales, ratio, as Shake Shack (SHAK) is still in the growth phase of its life cycle. During the growth phase, companies’ operating costs will be higher and their EPS (earnings per share) can’t be considered in the valuation.

Forward EV-to-sales ratio is calculated by dividing the company’s current enterprise value by forecasted sales for the next 12 months. Estimated future sales give more visibility to a company’s growth prospects.

SHAK’s EV-to-sales ratio

Since its listing in January 2015, Shake Shack’s (SHAK) EV-to-sales multiple has been 4.6x–18.3x. After listing, 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 the EV-to-sales multiple up. Since then, share prices have fallen as investors grew skeptical of the company’s future growth prospects, which also brought the multiple down.

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Since the announcement of its 1Q16 results on May 12, 2016, the company’s EV-to-sales multiple has increased from 4.8x to 5x. Its raised revenue and EPS guidance for 2016 has increased investor confidence, which has led to a rise in its share price, and the rise in share price has increased its enterprise value, pushing the EV-to-sales multiple up.

During the same period, peers Chipotle Mexican Grill (CMG), Panera Bread (PNRA), Brinker International (EAT), and the Cheesecake Factory (CAKE) were trading at EV-to-sales multiples of 2.7x, 1.9x, 1.1x, and 1x, respectively.

Risks and uncertainties

Compared to peers, Shake Shack is trading at a higher valuation multiple due to the opportunity that the company has to expand. If the expansion of its business fails to generate expected revenue, however, it could push the share price and valuation multiple down. In the next four quarters, analysts are expecting sales of $266.7 million, which represents a growth of 29% over the previous year. If the company reports lower sales, SHAK’s stock could face selling pressure, which could also bring the EV-to-sales multiple down, and vice versa.

In the next and final part, we’ll look at what analysts are recommending for Shake Shack ahead of its 2Q16 results.

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