I am a huge proponent of following Peter Lynch's mantra of buying what you know in the stock market. Mr. Lynch intended for this saying to be the impetus that launched further research into the company, rather than as the only reason to make a buy or sell decision in the stock market. When used correctly, it can be a powerful way to create investment ideas to explore for your portfolio.
I was thrilled to see the success of Shake Shack (NYSE: SHAK). Starting out as a humble hot dog cart in Manhattan, the company launched its IPO in January 2015. Given the simple start, the IPO alone was a testament to American capital markets and our never-ending love of fast-food hamburgers. However, Shake Shack continued to surprise and confound critics, with shares more than doubling on their first day of trading. Even more, the stock continued to rocket higher over the next few months, topping out in the $95 per share zone.
I was excited to try Shake Shack due to all the hype on and off Wall Street. When a location opened up near my home, I jumped on the opportunity to try these burgers I had heard so much about!
Talk About Being Disappointed!
It was a terrible experience. After waiting in a long line, I was served a dried-out meat patty with french fries that looked like they were from the supermarket frozen food aisle. Thinking I may have just had a bad experience, I ventured into several other Shake Shack locations to experience the food. Each time I was equally disappointed with the quality and taste of the burgers. There was no comparison between the Shake Shack burgers and fries and those of the other new-wave burger joints. I quickly reached the conclusion that Shake Shack offers a vastly inferior product and is powered by nothing but hype.
Around this same time, the stock started falling off its previous highs. Investors must have started catching on to the hype and sharply overpriced shares. In fact, the most current reading of short percentage of the float is greater than 40%.
Usually, I would take this ultra-high short reading to be a contrarian bullish signal. However, when combined with my experience with the food, the technical picture, and fundamental metrics, the crowd is right this time.
The Fall From Grace
Shares are lower by just over 11% this year and nearly 39% over the last 52 weeks. Trading volume averages just over 750,000 shares per day with a 16,560,000 share float.
Presently, the company boasts an incredibly high valuation multiple of about 58 times forward earnings. Placing this unsustainable number into perspective, this is nearly three times the forward earnings multiple for McDonald's (NYSE: MCD).
In addition, the news that same-store sales have disappointed over the last 2 out of 3 months and insiders are dumping shares since the lock off came off paints a very bearish picture. The five largest shareholders have recently taken profits by selling over 5.8 million shares for $211 million.
This chart from Hedgeye does an excellent job of illustrating the massive insider selling. Every red arrow is an insider sell:
As you can see, insiders are dumping the shares on every rally. Even if the shares just look like a rally is starting, the insiders are taking profits. Insider selling is a nebulous indicator. However, when it is en masse, like it is with SHAK, it can be an ominous signal for the shares.
Wedbush, a large financial services and investment firm, has come out with a statement saying it expects an increase in same-store growth headwinds and that new location upside potential is less likely in 2017. The firm has set an Underperform rating on the shares.
While bullish investors often compare SHAK with Chipotle (NYSE: CMG), there are radical differences between the two. Despite being a cult favorite in hot zones like New York City, SHAK is just another "me too" burger joint with an inferior product. Chipotle, on the other hand, has a disruptive model that changed the entire serving concept of fast food. They also bring something else SHAK doesn't: a truly fresh, new taste to the American fast food-eating public.
SHAK bulls are very excited about the test of a new smartphone app that allows customers to order ahead of time to bypass the lines. While this is an excellent idea, the reality of the benefits may be far different. Should enough customers adopt the app, it seems that all it will accomplish is moving the line from the order side to the pickup portion of the counter.
Risks To Consider: Third-quarter earnings are released on November 3. I expect a miss of the overly optimistic estimates and the downward trend to continue. However, the company may continue to post solid numbers resulting in a short-term upward spike. Be alert around the earnings date!
Action To Take: Short SHAK now on the weak bounce from the lows near $32 per share. I expect to see SHAK trading below $15.00 per share within the next 15 months. Initial stops are suggested at $36.23 per share.
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