Here’s the Problem With Shake Shack Stock
I love Shake Shack Inc. (NYSE:SHAK) as a restaurant. The chain offers great burgers, awesome fries, and an amazing atmosphere. However, when it comes to SHAK stock, it’s a completely different story.
Short sellers are very active in the current fragile stock market, which is absent of any major new catalyst to propel stock prices higher. The bearish sentiment is evident despite the recent October stock market rally.
First, the rally was relatively narrow, which means it was somewhat led by the big banks and brand-name technology sector names. If you are long, you should be careful, as the downside vulnerability remains high, especially with the small-cap stocks and higher-beta momentum stocks that would make early 21st Century value investor Benjamin Graham shutter.
I don’t think we are repeating the colossal backlash that swamped the equities market in 1987 and 2000, but you never know, given how the six-year-plus gains were largely due to the free spending by the Federal Reserve.
The Big Short
You likely have heard about the current attack by short seller Andrew Left of Citron Research on the shares of Valeant Pharmaceuticals International, Inc. (TSE:VRX). The stock is trading in the low-$70.00 level after trading as high as $263.00 on August 6, 2015.
Last week, we saw the stock market destruction of GoPro, Inc. (NASDAQ:GPRO) to below its initial public offering (IPO) price of $24.00 in June 2014. The stock traded as high as $86.00 in November 2014 until short sellers attacked the stock.
For GoPro, which I have discussed in a previous commentary, the issue is that the company essentially produces one great product: the durable, mountable camera that has astounded the world with amazing high-definition video. It’s a great concept, but it’s also something that is highly susceptible to competition.
In my last commentary on the subject, I suggested Apple Inc. (NASDAQ:AAPL) should buy GoPro, which would complement its product line. Apple could easily buy GoPro for between $3.0 billion and $4.0 billion. I’m not sure if this would happen or if another company like Alphabet, Inc. (NASDAQ:GOOG) would snag it first, but for GoPro, it will be tough moving forward as a single-product company.
Chart courtesy of www.StockCharts.com
The IPO market is now stalling. New issues are being canceled and previous IPOs are languishing as the stock market becomes increasingly picky about crazy valuations.
Shake Shack Could Be the Next GoPro
The hyped-up IPO market brings up one of my top companies to hate: Shake Shack Inc.
The seller of expensive gourmet burgers has a loyal following on Wall Street and among investors and diners. Despite this, I have always considered the stock as overvalued and worth a short. When I talked about Shake Shack in May, the stock was trading at $72.00, reaching as high as $96.75 the same month. So far, my bearish thesis on the stock has played out since then, with a decline to the current $40.00 level.
Chart courtesy of www.StockCharts.com
SHAK stock’s market valuation has plummeted from $2.6 billion when I last discussed the stock to $1.5 billion today. My short thesis on Shake Shack still holds.
The stock is valuing each of the 75 stores in the network at around $20.0 million each—a crazy valuation. The stock trades at a hefty 106 times its 2016 earnings per share and 4.6 times its estimated five-year earnings growth rate, which is way overdone.
The third quarter saw the company report revenue growth of 67.4% year-over-year, which is a nice number on the surface, but the valuation still doesn’t make any sense. Shake Shack said its same-store sales surged 17.1% in the third quarter, but this was based on 16 stores versus 12 a year earlier; we need to see a much bigger sample to get a better picture. Management said it was on target to open 12 new stores this year, followed by another 14 new domestic strikes in 2016 and thereafter.
The burger network could run up to 90 stores in a few years,but so what? The chain is too small to deserve the valuation assigned by the stock market. Double the number of stores with a similar growth rate, and I may bite, but not now.
The bottom line: I love Shake Shack’s burgers, but hate the SHAK stock at its current levels.