Shake Shack Inc's IPO Is Too Rich for My Blood

By Markets Fool.com

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Source: Shake Shack.

Last week, I wrote a positive article on burger chain Shake Shack's IPO on the basis that, "in [the indicative $14 to $16] price range, the shares could significantly undervalue Shake Shack's growth potential." The shares began trading today, and I'm much less excited about the offering. In fact, I think investors ought to avoid the stock entirely. What's changed?

Is no price is too high?
It's not unreasonable to think a stock that is attractive at $15 may well be repulsive at more than three times that price -- which is where Shake Shack shares are now trading. (The stock was at $48.62 at 12:30 p.m. EST.) Indeed, the underwriters raised the price range to $17 to $19 -- and the number of shares being sold -- before finally pricing the shares at $21.

Apparently, that did nothing to deter investors once shares began trading in the second market this morning they opened at $47, for a 124% pop! Despite solid or even outstanding fundamentals, a business will not support any valuation. Price matters.

Last week, I compared Shake Shack to Chipotle Mexican Grill . Let's see how the share valuations of the two companies on their first day of trading now compare:

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Number of restaurants operated by the company at the time of the public offering

Price / TTM Sales
(based on closing price on first day of trading)*

Chipotle

453

4.4

Shake Shack

26

16.1

*Shake Shack's price-to-sales multiple is based on the $48.62 price at 12:30 p.m. EST. Source: Company documents.

That's a huge gap between the two price-to-sales multiples! Given the massive appreciation in Chipotle's stock price since the close of its first day of trading -- a more than fifteenfold increase in just more than nine years! -- there's a good argument to be made that the shares were undervalued at that time.

However, had Chipotle closed at $160 instead of $44 on its first day of trading -- which would equalize the price-to-sales multiples -- subsequent gains would have been significantly less impressive.

Buy potential performance at a discount, not a premium
Furthermore, with Chipotle, we are looking back at performance that has already been achieved, both in terms of the stock and the company's operations. The Mexican chain has executed superbly well during that period.

With regard to Shake Shack -- however likely you think a similar business performance is -- it remains in the realm of possibility instead of certainty. I don't know about you, but when I buy possibility, I like to buy it at a discount to the price of certainty.

Although I think Shake Shack's brand positioning is comparable, and possibly even superior, to that of Chipotle, I'm not convinced the business fundamentals are as attractive.

For one thing, Shake Shack faces stiffer competition in its segment than Chipotle did (or does) in the likes of Five Guys and In-N-Out Burger. For another, Shake Shack's same-store sales growth is significantly lower than Chipotle's was, at just 3% for the 39 weeks ended Sep. 24 versus 10.2% for Chipotle in 2005, which was followed by 13.7% in 2006.

Don't swallow these shares
Shake Shack may produce a premium burger -- founder Danny Meyer refers to this segment as "fine casual dining" -- but the stock is currently selling at a super-premium price. Paying that price is the equivalent of eating "empty calories" -- it could end up being detrimental to your financial health.

The article Shake Shack Inc's IPO Is Too Rich for My Blood originally appeared on Fool.com.

Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.