Among the factors that investors use in making investment decisions, valuation multiples are driven by investors’ willingness to pay, growth prospects, risks, and uncertainties.
Of the various valuation multiples, we have opted for the forward PE (price-to-earnings) multiple due to its high visibility in Papa John’s (PZZA) earnings. The forward PE multiple is calculated by dividing the current stock price by forecast earnings for the next four quarters.
Forward PE multiple
Papa John’s better-than-expected 1Q17 earnings and sales appear to have increased investors’ confidence, leading to a rise in its stock price and forward PE multiple. On May 4, 2017, Papa John’s (PZZA) was trading at a forward PE multiple of 27.6x compared to 27.3x before the announcement of its 1Q17 earnings.
Papa John’s (PZZA) launched two menu pilot programs, which we discussed in Part 3 of this series. The company also implemented Papa Track, which allows customers to track their pizzas from order to delivery.
These initiatives are expected to increase Papa John’s expenditures. If these initiatives fail to generate the expected sales, the increased expenditures could put pressure on the company’s margins and lower its earnings.
For the next four quarters, Wall Street analysts expect Papa John’s to post EPS growth of 11.7%, which could have been factored into Papa John’s current stock price. If the company’s earnings are lower than estimated, the selling pressure could bring Papa John’s valuation multiple down.
You can mitigate these company-specific risks by investing in the iShares Dow Jones US Consumer Services ETF (IYC), which invests 11.1% of its holdings in restaurants and travel companies.
In the final part of this series, we’ll look at analysts’ recommendations and target prices for Papa John’s (PZZA).