2 Overhyped Restaurant Brands Hope for a Better Future

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Twice this year, restaurants have come along with IPOs that shook the market up. Both Potbelly (NASDAQ: PBPB  ) and Noodles & Co. (NASDAQ: NDLS  ) jumped in the days immediately following their first appearances, offering investors who missed out on other big chains a chance to redeem themselves. But since then, the stocks have both suffered. Noodles is down 19% from its first-week high, and Potbelly has dropped 6.7% from its opening-day value. The fall is due to a healthy mix of hype, greed, and good old-fashioned reality.

The hype-greed cycle
The main drivers of those early gains were previous successful IPOs and the PR machine behind a good IPO. Both companies came into the market with lots of coverage, due in part to the lack of restaurant IPOs in the past year. The premise was simple -- here are businesses that everyone understands and that are growing.

Noodles had been profitable for years before its IPO, and sales were climbing rapidly. The company also made the bold move of expanding during the downturn, showing that it had the gumption to make the best of any situation. It also came with some names everyone loves, including an ex-Chipotle management team. Potbelly offered a similar situation. It was the next big thing after Noodles -- and remember how good that was? -- and it too was growing.

Both of these PR stories played off our natural greed. Not greed in the "What's mine is mine" sense, but in the "Man, I missed out on a winner" sense. Chipotle and Buffalo Wild Wings are the ones that got away. Since their IPOs, both companies are up more than 1,100%.

The reality
Before we dive into how reality brought us back down to earth, let me say this: I think both of these business are good. I don't know if they're great, and I certainly don't think they deserved the hype they got, but they're not bad restaurants or businesses, and they have every chance to go on to be fantastic investments.

The reality is that growth comes slowly. Buffalo Wild Wings didn't really break out until 2008 and 2009, when the company started to aggressively expand. Chipotle followed a similar path, bumping along until 2009, when the company finally figured out the formula.

Neither Potbelly nor Noodles & Co. is there yet. Potbelly, for example, is pushing revenue up, but has yet to really hit a surge in new stores. Last quarter, sales rose 11.7%, with comparable-store sales up 2.5%, but the company only added nine locations. Is that worth a price-to-earnings ratio of more than 1,000? Not to me, not yet.

The lesson
There's nothing wrong with buying a hyped stock if you like the company, like the price, have plans to hold for the long run, and know that you're paying for hype. While Chipotle investors could have made more by buying at the dips, I can't imagine anyone is upset about picking the stock up for $44 -- double the IPO price but a twelfth of the current share price.

Potbelly has been on the rise this month, reporting strong third-quarter earnings and sales growth. Already, the company is working its way back to those good early days. As a long-term investor, these ups and downs should just roll off your back. Let the market correct, and let the stock grow based on the company's strong fundamentals. Noodles and Potbelly may still make a splash, but the hype surrounding the IPO was premature.

The beauty of a good fresh stock
One of the fun parts of investing in new companies is watching that long growth expand over time. But sometimes you want more faster. Investors who are tired of watching their stocks creep up year after year should check out Motley Fool co-founder David Gardner's unique strategy for uncovering truly wealth-changing stock picks. He's written a guide to share his vision, along with a few of his favorite growth stock superstars, in our free "6 Picks for Ultimate Growth" report. So stop settling for index-hugging gains and click here for instant access to a whole new game plan.

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Related Tickers

9/30/2016 4:00 PM
PBPB $12.43 Down +0.00 +0.00%
Potbelly CAPS Rating: **
NDLS $4.76 Down +0.00 +0.00%
Noodles and Co. CAPS Rating: *