Ever since its initial public offering in 2015, Shake Shack Inc. (SHAK, Financial) has been trading at a hefty premium compared to its peers in the restaurant industry. Investors have been eagerly waiting for the “next Chipotle” and have put high premiums on many stocks in the restaurant sector. Although Shake Shack has nice product offerings and is a good business, the stock’s valuation remains a bit too high.
Stocks with high valuations run the risk of crashing on the slightest bit of negative news, which is exactly what happened when Shake Shack released its quarterly report earlier this month.
For the fourth quarter, Shake Shack’s EPS came in at nine cents, which was in line with the consensus. The company’s revenue, which grew an impressive 43% year over year, came in at $73.3 million, surpassing the analysts’ estimate by $2.62 million. Despite the stunning growth and double beat, Shake Shack has fallen almost 10% since the earnings came out on the back of shrinking margins.
Businesses in the restaurant industry that grow as fast as Shake Shack are usually unprofitable and focus on growth. So, credit where due, Shake Shack’s profit has improved consistently along with its earnings. I think investors are irrationally punishing the stock for a minor blip.
The company keeps knocking the quarterly results out of the park and is highly profitable considering it is still growing and has a lot of room to expand. While the stock is currently trading at a price-earnings ratio of 76, it can become more conservative in the near future due to consistent increases in revenue.
On the flipside, Shake Shack’s comps have taken a breather as it missed the fourth-quarter target, which has been a trend ever since the company started its rapid expansion.
Going forward, I expect Shake Shack to continue growing at a rapid rate. That being said, the company’s margins will likely take a hit on account of its aggressive expansion initiatives. The stock may be trading at a high valuation currently, but long-term investors can capitalize on the current dip and buy the stock. Shake Shack will likely grow into its current valuation sooner rather than later and since it still has a lot of room to expand, I think it makes for a good buy on the dip.
Disclosure: No position.
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