Tastes are fickle, and the market can quickly lose its appetite for the flavor of the month. This is particularly true of companies that sell familiar or popular products. People latch on to these companies, reasoning that if they enjoy the product, then the stock must also be great.
Many of you don't remember Boston Chicken, the precursor to Boston Market. For a short time, the stock was a stellar performer. On its November 1993 debut, the stock shot from $10 to $23. After all, it was a great concept -- a fast-food restaurant that sold chicken, but at the same time was vastly different and offered a superior product compared with its competitors. Boston Chicken seemed like a revolutionary concept 20 years ago.
By late 1996, the stock traded above $40. Two years later, shares would be worth pennies and the company would file for bankruptcy, a victim of overly aggressive expansion.
I still enjoy dining at Boston Market occasionally, just as I enjoy an occasional visit to Shake Shack (SHAK). I'm not saying Shake Shack is the next Boston Chicken, because the two situations are very different. However, both are popular brands that became overstretched after their respective IPOs.
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Shake Shack is unlikely to make the same mistake that Boston Chicken made in terms of expansion; in fact, the company only plans to open a total of 450 locations in the U.S. But with that ceiling on its locations, it'll be a long time before SHAK grows into its current valuation, and that's assuming nothing goes wrong along the way.
If I were a SHAK bull, I'd be worried about yesterday's market action. On a day when stocks rallied sharply, Shake Shack got smoked, losing 14% on heavy volume. SHAK has formed an evening star reversal pattern (shaded yellow), and the price action of the past two sessions has engulfed its recent rally.
For a casual dining chain, the stock's valuation is simply too high. Perhaps SHAK deserves a premium to its peers, because its products are excellent. However, no stock deserves an enterprise-to-EBITDA ratio above 90, or a trailing price-earnings ratio of over 1000. Even if SHAK's product is ten times better than, say, Sonic Corp. (SONC), it doesn't necessarily deserve a multiple that is over ten times as high.
SHAK's current valuation must have chains like Five Guys Burgers and Fries and In-N-Out Burger licking their chops at the thought of possibly going public. That brings up another issue: there is plenty of competition in this arena, and the barriers to entry are relatively low. There are only so many ways to prepare food, and Shake Shack's not-to-secret formula of high-quality, antibiotic-free burgers could be easily duplicated. Simply put, I like the product a lot more than I like the stock.