The booming public stock market has been good for investors this year. However, there have been some companies that have absolutely crushed the broader indices.
To take Cava (NYSE: CAVA). The emerging fast-casual restaurant chain has seen its shares rise 177% by 2024 (as of December 20), despite taking a breather in the past few weeks. Maybe you’re ready to take a bite out of this unstoppable situation restaurant inventory.
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But first, take a step back. Before you even think about adding Cava to your portfolio, consider this one important caveat.
Expectations are sky high
Buying and holding companies for the long term is a great way to grow your wealth in the stock market. However, if you pay too much for a company, the potential to earn strong returns decreases.
This is exactly what I consider to be the main risk among those looking to own Cava. At the time of writing, the stock is trading at a nosebleed valuation. The price-to-sales ratio (P/S). of 15.3 is an insanely high multiple. It’s worth noting that the stock’s gains in 2024 can be attributed almost entirely to its growing price-to-earnings ratio, which is up 171% this year.
This clearly shows how enthusiastic the market has become Cava’s prospects. It’s as if investors believe the company can do no wrong. On the one hand, this could make sense, as revenue and net income rose 39% and 165%, respectively, in the third quarter (ending October 6).
But all else being equal, it’s always better to pay a lower valuation for a company than a higher one. In Cava’s case, if the company delivers financial results that are slightly lower than Wall Street expectations, the stock could take a nosedive.
Looked at another way, Cava must continue to deliver financial results that exceed already lofty expectations to drive its share price higher. That’s a huge question.
Compare Cava to Chipotle
It makes sense that investors could see Cava as the next one Chipotle Mexican Grill. The Tex-Mex restaurant concept has shown enormous sales growth in recent years, both through a combination of opening new locations and stimulating sales in the same store. Profitability is also great, as Chipotle reported a stellar operating margin of 16.9% in the third quarter (ending September 30).
And perhaps most importantly, Chipotle has undoubtedly developed sustainable competitiveness. Brand presence in the restaurant industry should not be taken for granted. The company successfully recovered from the E. coli outbreak in 2015, regaining customer trust and achieving excellent financial performance.
Moreover, with a total of 3,615 stores, Chipotle has economies of scale that smaller chains simply do not have. The company can get better prices for raw materials such as food and packaging. It has the resources to acquire favorable real estate for new locations. And Chipotle can better leverage fixed technology and marketing costs across a much higher revenue base.
So while Chipotle has already proven itself as an incredibly lucrative restaurant chain, Cava is still a long way off. In fact, I think there’s a much better than 50% chance that Cava is nowhere near Chipotle’s scale.
But as of this writing, Chipotle’s stock is trading at a price-to-earnings ratio of 7.8, about half of Cava’s valuation. In other words, every Chipotle location has one market capitalization of $23.3 million. In contrast, each Cava store is valued by the market at $38.8 million.
It is clear that Cava’s valuation has come under extreme pressure, which is a major risk for investors. Not only that, but it’s nowhere near the same level as Chipotle.
Long-term investors still interested in Cava should continue to monitor the company’s progress and ensure key financial metrics are moving in the right direction. Once this condition is met, it’s all about patience and waiting for a much more attractive valuation.
Should you invest $1,000 in Cava Group now?
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Neil Patel and his clients have no positions in the stocks mentioned. The Motley Fool holds positions in and recommends Chipotle Mexican Grill. The Motley Fool recommends Cava Group and recommends the following options: Short December 2024 Put $54 on Chipotle Mexican Grill. The Motley Fool has one disclosure policy.