Should Shake Shack's Shares Have Sunk So Sharply?

If Shake Shack (NYSE: SHAK) had been founded in, let's say... Columbus, Ohio -- the birthplace of both Wendy's and Buffalo Wild Wings -- investors wouldn't hear nearly so much about it. It has only 250 or so locations, after all. But with its base in New York City, the stock seems to be powered by a fair amount of home-team hype. What that means in real terms is that the stock is trading at an extremely high earnings multiple. Lower now, though, after a not quite as good as expected third-quarter report.

In this segment of the Nov. 5 MarketFoolery podcast, host Chris Hill and MFAM Funds' Bill Barker discuss the wild ride that the stock has taken relative to the smooth growth story of the underlying business, whether its exclusivity deal with Grubhub (NYSE: GRUB) could have been wise, the outlook, and more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

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This video was recorded on Nov. 5, 2019.

Chris Hill: Let's move on to Shake Shack. Yesterday, there was a headline I saw, and the headline was, "Will Shake Shack's Spectacular 2019 Continue With Its Third Quarter Report?" And the answer appears to be a resounding no. Shake Shack, down 20% today. Same-store sales in the third quarter came in at 2%. That's only 0.5% lower than what was expected. But I think, to go back to the headline, it actually has been a very good year for this stock. Shake Shack has moved into this category as a business, maybe we're not expecting perfect results for them, but in this environment, if they're going to miss, then we're taking some money off the table. 

Bill Barker: Yeah, a lot of things to say about this one. One, to focus on that headline, as to what was spectacular? Was it Shake Shack's business year or the stock year? The stock year had been spectacular. One wonders why, to that degree. If you look at a chart of Shake Shack, it's one of the companies that I like to refer to as a stock having visited lots of different interesting places. It skyrocketed after its IPO. Got up to, I don't know --

Hill: $90. It was north of $90.

Barker: Came down to $30. After that, back up to close to $90 again. Now it's at $60-some. And if you look at the actual operations, it's a fairly smooth growth story, which just doesn't have quite the highs and lows that the chart would suggest. It's trading at 100X earnings. Same-store sales are 2%. Yes, it can open a bunch of stores, but why are people paying 100X earnings for this company? I think they're asking themselves that, based on the 20% drop in the stock today.

Hill: Even with the drop that we're seeing today, the stock is still up around 50% year to date. It is interesting, though, because you're right, this is not a business that has been what I consider to be overly aggressive with their expansion plans. They've been pretty steady with it. I'm not really sure why they are afforded the multiple they're afforded. I assume at least part of it has to do with a decent concentration of its locations in New York City.

Barker: Possibly that, possibly having captured because of that some of the financial media's attention. The amount of mentions that Shake Shack gets on something like CNBC in proportion to the size of its business is fairly odd. But it's a good growth story. It is actually profitable, as it should be, given its size and the business that it's in.

One of the problems with this report was, it referenced that it is moving from using a number of different delivery services to only using Grubhub. That is going to impact sales to the downside, which makes one wonder just how much is Grubhub offering Shake Shack to be the sole provider of delivery services for Shake Shack? How much is that worth it to Shake Shack, to sacrifice some additional sales? They must be getting a pretty sweet deal from Grubhub. If you look at Grubhub's stock price, you'll see that it must have gotten into a lot of bad deals, because it's going nowhere.

Hill: Yeah, I think this is something to keep an eye on just from the standpoint of whether it's 2020 or thereafter, be on the lookout for one of these two companies being quick to announce, "We're no longer part of this deal."

Barker: You've got to wonder what is in it for Shake Shack. They are highlighting that as something which is certain to create uncertainty about the rest of the years' same-store sales.

Hill: Which, by the way, they lowered guidance for that for the full fiscal year as well.

Barker: Right, in part because they're just going to be delivering and selling less because they're in a number of markets -- I think Grubhub is very dominant in New York, but not so much in many other markets where Shake Shack needs to have its food delivered. And if people can't get it delivered through their preferred vendor, then they may just not be getting anything from Shake Shack. It's bringing same-store sales down 1.5% or something, is the guidance. There are fairly small increments that this is moving around by. But, it is moving, as it always has ,the stock much more than the business itself.

Bill Barker is an employee of Motley Fool Asset Management, a separate, sister company of The Motley Fool, LLC. The views of Bill Barker and Motley Fool Asset Management are not the views of The Motley Fool, LLC and should not be taken as such. Bill Barker has no position in any of the stocks mentioned. Chris Hill has no position in any of the stocks mentioned. The Motley Fool recommends Grubhub. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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