Valuation multiples help 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.
There are various multiples available, but we’ll use an enterprise value-to-sales ratio, or EV-to-sales ratio, for Shake Shack (SHAK) because the company is still in the growth phase of its life cycle. (During the growth phase, a company’s operating costs will be higher, and its earnings per share can’t be considered in the valuation.)
The 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 the announcement of its 2Q16 results on August 10, 2016, the company’s EV-to-sales multiple has fallen from 5.1x to 3.7x. Lower-than-expected 2Q16 same-store sales growth and softening growth in restaurants overall due to the sluggish US economy have made investors skeptical about SHAK’s future earnings, which has led to a decline in its share price and PE multiple.
As it’s still in its growth phase, SHAK enjoys a higher valuation multiple than peers. On the same day, Chipotle Mexican Grill (CMG), Panera Bread (PNRA), and Brinker International (EAT) were trading at valuation multiples of 2.3x, 1.6x, and 1.3x, respectively.
Analysts are expecting the company to post revenues of $296.3 million in next four quarters, which represents a growth of 31.7% from corresponding quarters of the previous year. SHAK’s current share price might have factored in this revenue growth. 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.
You can mitigate company-specific risks by investing in the iShares Russell Mid-Cap Growth ETF (IWP). IWP invested 53.4% of its holdings in restaurants and travel companies.
In the next and final part of this series, we’ll look at analysts’ recommendations for SHAK ahead of its 3Q16 earnings.