The Clearest Indication Yet That Shake Shack Stock Is Overvalued

By Markets Fool.com

Continue Reading Below

Source: Shake Shack

Shake Shack (NYSE: SHAK) is one of the hottest stocks around. Shares of the burger restaurant closed at $45.90 -- more than twice the initial offer price -- on the first day of trading following its highly touted initial public offering in January. Since then, the stock has been on an absolute tear, soaring above $95 per share at its all-time high. Such incredible gains inevitably raised concerns that the stock was rallying too far, too fast.

The stock has since then come down to about $75 per share, but even now, shares look extremely overvalued.

Valuation will give you indigestion
Shake Shack has been undeniably successful. Last quarter alone, the company grew total revenue by 56% and same-restaurant sales by nearly 12% over the year-ago period. But while impressive on the surface, high growth rates are rather customary for companies in the early stage of development. As you will see below, other restaurant stocks are posting similar growth rates.

Given its small size, the greatest concern is whether Shake Shack can reasonably grow into its valuation.

Continue Reading Below

Shake Shack has a nearly $3 billion market capitalization. At the same time, the company operates just 66 restaurants. That equates to an implied valuation of approximately $45 million per location, which is an astronomical figure when stacked up against competitors with similar market caps.

Consider Sonic Corp. (NASDAQ: SONC) and Jack in the Box (NASDAQ: JACK)-- Sonic has a $1.5 billion market cap and operates roughly 3,500 restaurants, meaning each location is valued at about $428,000. Jack in the Box has a $3.2 billion market cap and operates about 2,800 restaurants which comes out to roughly $1.1 million per location.These figures are much more reasonable, and that $45 million per location may be the clearest indication yet that the lofty expectations for Shake Shack have gone too far.

Even on more traditional valuation metrics, the story remains the same. Shake Shack stock trades at a whopping 500 times forward earnings estimates, while Sonic and Jack in the Box trade for a much more reasonable 23 to 25 times earnings.

Growth strategy likely not enough
Investors buying into Shake Shack at these levels are likely counting on a rapid pace of new restaurant openings. And if that were the case, there would at least be some argument that the company could eventually justify its price tag, but that is unlikely.

For the remainder of the year, the company expects to open 10 new Shake Shacks in the U.S. and five abroad. That would still result in an implied valuation of approximately $37 million per restaurant.

Better burger stocks to buy
Most notably, both Sonic and Jack in the Box are growing at rates comparable to Shake Shack. Sonic's earnings per share doubled last quarter, thanks to an 11% increase in same-restaurant sales. Jack in the Box earnings per share soared 41% last quarter, as same-restaurant sales growth reached 8% at both Jack in the Box and Qdoba.

Sonic stock also yields 1.2%, while Jack in the Box yields 1.4%, thanks to a recent 50% payout increase. These are not huge yields, but they serve as an added margin of safety for investors, and the payouts are likely to grow going forward.

Shake Shack is priced for absolute perfection, a classic case of market irrationality and excessive hype. Investors looking for exposure to the restaurant industry should consider less speculative companies -- Sonic and Jack in the Box are great places to start your research.

The article The Clearest Indication Yet That Shake Shack Stock Is Overvalued originally appeared on Fool.com.

Bob Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.