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 we can use to evaluate a stock. In this article, we’ll use the PE (price-to-earnings) ratio due to its high visibility in Wendy’s (WEN) earnings. The forward PE ratio is calculated by dividing the current share price by the forecasted earnings per share for the next 12 months.
Wendy’s PE multiple
Wendy’s has been focusing on food quality, the reimaging of restaurants, and menu innovations to improve its same-store sales growth. This strategy increased investor confidence, leading to a rise in its share price. However, due to increased EPS estimates for the next four quarters, Wendy’s PE multiple has fallen from 26.2x before 2Q16 earnings were released to 25.8x as of November 3, 2016. On the same day, McDonald’s (MCD), Jack in the Box (JACK), and Restaurant Brands International (QSR) were trading at 18.5x, 26.6x, and 19.1x, respectively.
For the next four quarters, analysts are expecting the company to post EPS growth of $0.40, which represents a decline of 4.2% from the corresponding quarters of the previous year. The company’s current share price may have already factored in a decline in EPS for the next four quarters. If the company posts earnings higher than analysts’ estimates, the share price tends to rise, pushing the PE multiple up, 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 restaurant and travel companies.
According to a Bloomberg survey of 33 analysts, 43.5% have given Wendy’s a “buy” recommendation, 52.2% have given it a “hold,” and 4.3% of the analysts are recommending a “sell.”
As of November 3, 2016, Wendy’s was trading at $10.8, and analysts are expecting the share price to reach $11.8 in the next 12 months, which represents a return potential of 8.6%. On the higher side, analysts are expecting Wendy’s share price to touch $14.5, and on the lower side, it’s expected to reach $9.