This “Hype Stock” May Be an Even Better Short than SHAK or TWTR
I’ve brought several high-profile “shorts” to your attention since we started Total Wealth, and I hope you’ve racked up some big gains by following along.
First, there was Twitter Inc. (NYSE:TWTR) (here). It has fallen 40% from the recent highs of $52/share (in April) and was down 14% this morning after earnings, now trading around $31/share. This trade still has a long way to go, given how poorly run the company is, not to mention the revolving C-suite door. It’s probably worth less than $10 at best.
Then there was Shake Shack Inc. (NYSE:SHAK) (here). I warned you within hours of it hitting a post-IPO peak of $96.75/share (in May) that the thing was a dud. It fell 50% to a low water mark of about $48. It’s back up to $61 or so as I write this, which means there’s plenty of fresh money for the taking and an entirely new group of shareholders for whom hope is an investment strategy. I still see it valued at no more than $0.66, using industry metrics.
Now I want to bring another opportunity to your attention.
This stock is even more insanely valued and has metrics that suggest it’s an even better, more profitable trade.
Right now it’s trading at $41/share and is probably worth no more than $1.36.
Bar none, the single biggest question I got following last week’s Shake Shack update was, “can I still short the Shack?”
Absolutely. Like Twitter, Shake Shack remains totally overvalued and that means there’s a lot of room to the downside.
The problem is that shorting Shake Shack is now a “crowded” trade, meaning a lot of people now know how badly overvalued the company is. Goldman Sachs and Morgan Stanley have also piled on, observing – like we have – that the company’s fundamentals do not support such lofty prices.
That’s why, in keeping with the Total Wealth Tactic of Looking Where Others Are Not, the better play is another trade that’s less well known, yet still has every bit of the profit potential and then some.
It’s a Hype Stock with a PE Ratio of 1,192
I’ve made no bones about my views on Shake Shack. The company makes great burgers but does not have the underlying numbers, growth, or menu needed to support a price that is still 339x forward earnings at $55 a share.
Neither does Zoe’s Kitchen Inc. (NYSE:ZOES). And its PE is even worse.
The snazzy Mediterranean joint – which makes delicious pizzas, wraps, salads, sandwiches, and kabobs for its customers behind plate-glass assembly lines within minutes – has been called “the Chipotle of its industry” by Yahoo! Finance and other mainstream investing outlets. Zoe’s Kitchen epitomizes how conventional fast food is losing market share to an up-and-coming style of restaurant – the “fast casual” – that occupies a niche in-between hamburger joints and formal eateries.
Analysts’ adulation is just one of many things Zoe’s Kitchen has in common with its fellow media darling and hype-stock du jour, Shake Shack.
However, even as Shake Shack has been drifting lower towards increasingly realistic valuations, Zoe’s Kitchen has surged more than 34% since early June.
To paraphrase baseball great Yogi Berra, “it’s like déjà vu all over again.”
The result is a ridiculous price-to-earnings (PE) ratio that puts Zoe’s on par with where Shake Shack was in May when I called it for what it was, despite the company’s status as a media darling.
As for how it got there, that’s the thing – Zoe’s is being driven by exactly the same hype, hope and irrational exuberance that made Shake Shack such a great short play.
For instance, Zoe’s shot higher on earnings of only $0.04/share on June 5th that surprised analysts who had expected another loss for the young company that’s been public for barely a year. SHAK’s earnings were also $0.04 per share.
Zoe’s PE ratio is now 1,192. SHAK’s PE ratio on the heels of its widely celebrated earnings report was also above 1,200, which, as I pointed out to you at the time, was an enormous red flag to any investor considering buying the stock.
To put that in context, the restaurant sector carries an average PE of 40.5, according to NYU’s Stern school of business. That means Zoe’s Kitchen’s stock is 30x more expensive than the industry as a whole – and like Shake Shack – ripe for an eye-watering correction that takes to down 96.7% to only $1.36 per share.
How’d I get there?
The same way I arrived at $0.66 for Shake Shack – by using industry comps.
Then there’s the trading itself. As you can see from the following chart, Zoe’s is on a very similar trajectory.
Growing into Its Valuation Won’t Work for ZOES
To hear the Zoe’s bulls tell it, the company will “grow” into its valuation. The implication is that “everybody else” is just too stupid to see that. It’s classic Silicon Valley/Wall Street logic and arrogance.
It’s also exceptionally dangerous for your money.
Growing into a valuation is something best left to tech companies like Apple Inc. (NasdaqGS:AAPL) or Tesla Motors Inc. (NasdaqGS:TSLA) – companies with the potential to change the world. Not a company that sells marinara on a pita or a burger and fries for that matter.
Remember, every company has two kinds of shareholders, and companies like Zoe’s make that abundantly clear.
There are long-time investors who believe in the brand; they’re owners. They rarely, if ever, sell. And there are flippers who buy and sell the stock on a whim. They’re usually “in” because they got shares at the IPO or as part of the early stage funding. They rarely give a damn about anything other than their money.
It’s a classic trap and one Wall Street uses very effectively to separate millions of unsuspecting investors from their money under the guise of growth and huge profits down the line.
Only this time you have what you need to make money when it’s sprung.
Exactly as you did with Twitter and Shake Shack.