Valuation multiples help investors decide on entry and exit points in securities. A company’s valuation multiple is affected by its perceived growth, risks and uncertainties, and investors’ willingness to pay. Various multiples can be used to determine stocks’ valuations. For this analysis, we’ll be using PE (price-to-earnings) multiples, given the high visibility of earnings for fast-food restaurant companies.
The forward PE ratio is calculated by dividing a company’s current share price with its forecasted EPS (earnings per share) for the next 12 months.
As of June 7, 2016, the eight fast-food and pizza companies that we’re reviewing were trading at a median PE multiple of 24.2x. Domino’s Pizza (DPZ), which started the year with a PE multiple of 27.2x, was trading at 29.4x as of that date.
Although DPZ’s 1Q16 results were lower than analysts’ estimates, the company’s PE multiple has continued to trade at higher multiple due to its expansion model. The company’s expansion model and higher same-store sales growth appear to have increased investors’ confidence, who seem ready to pay more to earn higher returns in the future.
By comparison, Restaurant Brands International (QSR) was trading at a PE multiple of 28.5x on June 7. Its increase in margins appears to have boosted the company’s EPS, which appears to have hiked investors’ confidence. QSR was followed by Wendy’s Company (WEN) and Papa John’s (PZZA), which had PE multiples of 27.4x and 26.2x, respectively, as of the same date.
YUM! Brands (YUM), McDonald’s (MCD), and Jack in the Box (JACK) were trading at PE multiples of 22.2x, 21.4x, and 21.2x, respectively, on June 7. Improvement in their EBIT margins and EPS probably pushed their share prices up, as well as their PE multiples.
Sonic (SONC), which began 2016 trading at a PE multiple of 24.1x, was trading at a PE multiple of 20.4x on June 7. Declines in revenues and a lower rate of expansion failed to impress investors, and so share prices declined, bringing the company’s PE multiple down.
Remember, you can mitigate these company-specific risks by investing in the Guggenheim S&P 500 Pure Growth ETF’s (RPG), which invested 44% of its holdings in travel and restaurant companies.
In the next and final part, we’ll see what analysts are recommending for the eight companies under analysis after their 1Q16 results.