Restaurants increase convenience and give many people a place to unwind. But the side dish is that they’re quite difficult to operate because high inventory and labor costs generally lead to thin margins at the store level. This leaves little room for error if demand dries up, and it seems like the market has some reservations as the industry has tumbled by 1.5% over the past six months. This drawdown was discouraging since the S&P 500 returned 8.4%.
Investors should tread carefully as any operational misstep or unforeseen change in preferences can have you catching a falling knife. Taking that into account, here are three restaurant stocks we’re swiping left on.
Domino's (DPZ)
Market Cap: $10.94 billion
Founded by two brothers in Michigan, Domino’s (NASDAQ: DPZ) is a globally recognized pizza chain known for its creative marketing and fast delivery.
Why Does DPZ Give Us Pause?
- Poor same-store sales performance over the past two years indicates it’s having trouble bringing new diners into its restaurants
- Demand will likely be soft over the next 12 months as Wall Street’s estimates imply tepid growth of 4.5%
- Free cash flow margin has shown no improvement over the last year
At $327.74 per share, Domino's trades at 16.1x forward P/E. To fully understand why you should be careful with DPZ, check out our full research report (it’s free).
Sweetgreen (SG)
Market Cap: $790.2 million
Founded in 2007 by three Georgetown University alum, Sweetgreen (NYSE: SG) is a casual quick service chain known for its healthy salads and bowls.
Why Do We Steer Clear of SG?
- Lagging same-store sales over the past two years suggest it might have to change its pricing and marketing strategy to stimulate demand
- 8.7 percentage point decline in its free cash flow margin over the last year reflects the company’s increased investments to defend its market position
- Depletion of cash reserves could lead to a fundraising event that triggers shareholder dilution
Sweetgreen’s stock price of $6.66 implies a valuation ratio of 131.8x forward EV-to-EBITDA. If you’re considering SG for your portfolio, see our FREE research report to learn more.
First Watch (FWRG)
Market Cap: $753.9 million
Based on a nautical reference to the first work shift aboard a ship, First Watch (NASDAQ: FWRG) is a chain of breakfast and brunch restaurants whose menu is heavily-focused on eggs and griddle items such as pancakes.
Why Do We Think Twice About FWRG?
- Disappointing same-store sales over the past two years show customers aren’t responding well to its menu offerings and dining experience
- Negative free cash flow raises questions about the return timeline for its investments
- High net-debt-to-EBITDA ratio of 8× could force the company to raise capital on unfavorable terms if market conditions deteriorate
First Watch is trading at $12.37 per share, or 62x forward P/E. Read our free research report to see why you should think twice about including FWRG in your portfolio.
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