A Sizzling Restaurant Stock, But Beware of the Valuation
The public equity market has been on fire this year, with some businesses leaving the broader indices in the dust. One such company is Cava, a fast-casual restaurant chain that has seen its shares soar 177% in 2024. While this performance is undeniably impressive, it’s essential to take a step back and consider a crucial warning before adding Cava to your portfolio.
The Dangers of Overpaying
Buying and holding companies for the long term is a great way to build wealth in the stock market. However, if you overpay for a business, your potential returns are significantly diminished. This is precisely the risk with Cava, which currently trades at a nosebleed valuation. The price-to-sales (P/S) ratio of 15.3 is an alarmingly high multiple, and it’s worth noting that the stock’s gain in 2024 can largely be attributed to the expanding P/S ratio, which has climbed 171% this year.
A Comparison to Chipotle
Some investors might view Cava as the next Chipotle Mexican Grill, given its impressive revenue growth and profitability. Chipotle has exhibited tremendous revenue growth in recent years, driven by a combination of new locations and same-store sales increases. Its operating margin is a stellar 16.9%, and the company has developed durable competitive strengths, including a strong brand presence and scale advantages.
A Valuation Disconnect
However, there’s a significant valuation disconnect between Cava and Chipotle. While Chipotle shares trade at a P/S ratio of 7.8, Cava’s valuation multiple is roughly double that. This means that each Cava store is valued by the market at $38.8 million, compared to $23.3 million for each Chipotle location. It’s clear that Cava’s valuation has gotten extremely stretched, which poses a significant risk for investors.
A Word of Caution
Long-term investors who are still interested in Cava should continue monitoring the business’s progress, ensuring that key financial metrics trend in the right direction. However, it’s essential to be patient and wait for a more attractive valuation before investing. Remember, it’s always better to pay a lower valuation for a company than a higher one.
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