Investors should look at valuation multiples when deciding whether to buy or sell a stock. Valuation multiples are driven by perceived growth, risks and uncertainties, and investors’ willingness to pay for a stock.
There are various multiples used to evaluate a stock. In this part, we’ll use the PE (price-to-earnings) multiple due to its high visibility in fast casual restaurants’ earnings. The forward PE multiple is calculated by dividing the current share price by the forecasted EPS (earnings per share) for the next 12 months.
As of December 8, 2016, Shake Shack (SHAK) was trading at a PE multiple of 68.1x, while Chipotle Mexican Grill (CMG) and Panera Bread (PNRA) were trading at PE multiples of 42.3x and 28.3x, respectively. Shake Shack, being in the growth phase of its life cycle, is trading at a higher multiple than other companies, as it has huge potential to expand its operations.
Since the beginning of fiscal 3Q16, Chipotle’s PE multiple has fallen from 48.9x to 42.3x, respectively. The lower-than-expected 3Q16 earnings and the announcement from its co-CEO that he was skeptical about the company meeting its 4Q16 earnings predictions made investors skeptical about its future earnings. Thus, Chipotle’s share price and PE multiple fell.
Since the beginning of fiscal 3Q16, Panera’s PE multiple has fallen from 28.6x to 28.3x. After strong 3Q16 earnings, analysts raised their EPS estimates for the next four quarters, which led to the marginal decline of its valuation multiple.
Analysts are expecting Chipotle, Shake Shack, and Panera to post EPS growth of 223.5%, 20%, and 12.1%, respectively, in the next four quarters. These EPS growth projections might have already been factored into the current share prices of Chipotle, Shake Shack, and Panera. If the companies’ results come in lower, then the stocks could face selling pressure, which could bring the PE multiples of Chipotle, SHAK, and Panera down.
You can mitigate these company-specific risks by investing in the iShares US Consumer Services ETF (IYC), which has invested 11.3% of its holdings in restaurants and travel companies.
In the next and final part of this series, we’ll look at what analysts are expecting from these fast casual restaurants.