Valuation multiples help investors in deciding whether to buy or sell a stock. This metric is driven by perceived growth, risks and uncertainties, and investors’ willingness to pay for a stock.
Of the various valuations, we are using the forward PE (price-to-earnings) multiple due to its high visibility in Shake Shack’s (SHAK) earnings. The forward PE multiple is calculated by dividing the current stock price by the forecast EPS (earnings per share) for the next 12 months.
SHAK’s valuation multiple
The lowering of SHAK’s EPS estimates and price target by Goldman Sachs led to a decline in Shake Shack’s stock price, which in turn lowered its PE multiple. On April 5, 2017, Shake Shack was trading at a PE multiple of 60.6x compared to the previous day’s PE multiple of 61.9x.
On the same day, SHAK’s peers Chipotle Mexican Grill (CMG) and Panera Bread (PNRA) were trading at respective PE multiples of 50.2x and 38.8x. As Shake Shack is still in the growth phase of its life cycle, it has considerable room for expansion. As a result, SHAK trades at a higher PE multiple than its peers.
Analysts expect Shake Shack (SHAK) to post EPS of $0.50 in 2017, which represents 8.7% growth from its 2016 EPS of $0.46. Shake Shack’s current stock price may have factored in this EPS growth. If SHAK’s earnings come in lower than expected, the selling pressure could lower the company’s PE multiple.
You can mitigate these company-specific risks by investing in the iShares Russell 2000 Growth ETF (IWO), which invests 0.06% of its portfolio in Shake Shack.