From fast food to fine dining, restaurants play a vital societal role. But it’s not all sunshine and rainbows as they’re notoriously hard to run thanks to perishable ingredients, labor shortages, or volatile consumer spending. Unfortunately, these factors have spelled trouble for the industry as it has shed 4.8% over the past six months. This drawdown was discouraging since the S&P 500 held steady.
Investors should tread carefully as any operational misstep or unforeseen change in preferences can have you catching a falling knife. Keeping that in mind, here are three restaurant stocks we’re steering clear of.
Domino's (DPZ)
Market Cap: $14.6 billion
Founded by two brothers in Michigan, Domino’s (NYSE: DPZ) is a globally recognized pizza chain known for its creative marketing and fast delivery.
Why Does DPZ Worry Us?
- Lackluster 5.4% annual revenue growth over the last five years indicates the company is losing ground to competitors
- Anticipated sales growth of 5.3% for the next year implies demand will be shaky
Domino's is trading at $431.26 per share, or 24.4x forward price-to-earnings. Read our free research report to see why you should think twice about including DPZ in your portfolio.
Shake Shack (SHAK)
Market Cap: $3.51 billion
Started as a hot dog cart in New York City's Madison Square Park, Shake Shack (NYSE: SHAK) is a fast-food restaurant known for its burgers and milkshakes.
Why Does SHAK Give Us Pause?
- Responsiveness to unforeseen market trends is restricted due to its substandard operating profitability
- Poor free cash flow margin of 0.9% for the last two years limits its freedom to invest in growth initiatives, execute share buybacks, or pay dividends
- Negative returns on capital show management lost money while trying to expand the business
At $87.50 per share, Shake Shack trades at 70.2x forward price-to-earnings. To fully understand why you should be careful with SHAK, check out our full research report (it’s free).
Red Robin (RRGB)
Market Cap: $78.95 million
Known for its bottomless steak fries, Red Robin (NASDAQ: RRGB) is a chain of casual restaurants specializing in burgers and general American fare.
Why Do We Pass on RRGB?
- Lagging same-store sales over the past two years suggest it might have to change its pricing and marketing strategy to stimulate demand
- Earnings per share decreased by more than its revenue over the last five years, showing each sale was less profitable
- 14× net-debt-to-EBITDA ratio shows it’s overleveraged and increases the probability of shareholder dilution if things turn unexpectedly
Red Robin’s stock price of $4.55 implies a valuation ratio of 1.4x forward EV-to-EBITDA. Dive into our free research report to see why there are better opportunities than RRGB.
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