High expectations from investors
Robust growth in the restaurant industry, aided by strong fundamentals, has led to high expectations from investors. These expectations have, in turn, led to rich valuations in the sector.
Future earnings expectations also drive current stock prices
The graph above compares the current PE (price-to-earnings) ratio with the five-year average for Domino’s Pizza (DPZ), Papa John’s International (PZZA), and Jack in the Box (JACK). As you can see, all three stocks are trading at rich valuations compared to their long-term averages.
Domino’s Pizza, for instance, is trading at 40.0x its trailing 12-month earnings. Papa John’s is trading close to 33.0x its earnings, while Jack in the Box is trading at 25.0x its earnings.
Strong growth has caused investor expectations to rise. Future expectations are an important driver of stock returns (BITE).
Other factors affecting restaurant stocks
Lower interest rates have caused a general rise in store growth. For example, Shake Shack (SHAK) saw a 33.0% rise in store growth in 2014–2015, backed by lower interest rates.
Growth of the mobile sector has been a tailwind for growth in the restaurant industry. With mobile apps (applications), including menus, rewards programs, order ahead, and delivery, the restaurant industry is in the palm of the consumer’s hand, so to speak.
Certain areas are less penetrated than others. For example, Shake Shack is very profitable in New York City. The stores there are small, but they’re popular among New Yorkers. Outside of New York City, the stores are larger but less profitable.