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Potbelly and Noodles: Should You Buy on Weakness?

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2013 was an incredible year for initial public offerings, with more than 200 companies joining the market and the majority of them spiking higher in the first day of trading. Two of the hottest IPOs were Potbelly (NASDAQ: PBPB  ) and Noodles & Company  (NASDAQ: NDLS  ) , but both have fallen hard since being in the spotlight. Is this our opportunity to buy, or should we avoid trying to catch a falling knife? Let's find out...

The newborns
Potbelly owns and operates Potbelly Sandwich Shops. Its products include sandwiches, soups, salads, and shakes, all of which are made fresh to order. The company's vision is to become "The Best Place for Lunch" in every market in which it opens a location. Potbelly was founded in 1977 and went public in October 2013.

Noodles & Company is a fast-casual restaurant chain that offers the world's favorite noodle dishes, sandwiches, salads, and soups. The core principle of the company is that quality food can be served fresh, fast, and in an inviting atmosphere, without emptying the wallets of its customers. The company was founded in 1995 and went public in June.

First day pops & rallies
On Oct. 4, 2013, Potbelly went public at $14 per share, but the market had other ideas; shares opened for trading at $28.66 and ended the day 119.8% above the IPO price at $30.77. The stock continued higher over the next trading days, reaching its highest level to-date, $33.90, on Oct. 8, 2013.

Noodles' shares hit the market on June 28, 2013 at the price of $18, but it too opened much higher than that; it opened for trading at around $35 and ended the day up 104.2% at $36.75. The stock continued rallying, reaching its 52-week high of $51.97 on July 2, 2013, 188.7% above the IPO price. 

Drop it like it's hot
Since the aforementioned 52-week high of $33.90 for Potbelly, it has fallen more than 27%. However, this has nothing to do with an earnings miss in its first report on Nov. 12, 2013; take a look at the results versus the expectations:

Metric Reported Expected
Earnings Per Share $0.15 $0.09
Revenue $78.0 million $77.88 million

Potbelly's earnings per share increased 25% and revenue rose 11.7% year over year as comparable-restaurant sales grew 2.5%; the beat sent shares surging 9.3%, but it has fallen more than 24% since.

The decline began when more and more analysts began comparing Potbelly to Panera Bread, and a debate began as to whether Potbelly could grow at the same pace. This is never a good way to look at things because Potbelly is focused on "operating the business and delivering long-term shareholder value." These are the words of Potbelly's CEO, Aylwin Lewis, and I believe he knows how to keep expansion going while remaining competitive in the industry.

If anything, Panera investors should be worried about Potbelly taking share. With this said, Potbelly is now trading below the level it opened on the day of its IPO.

Noodles' stock price jumped around for several weeks after its IPO before starting a steep decline after reporting earnings on Nov. 6, 2013. Here's an overview of the results:

Metric Reported Expected
Earnings Per Share $0.11 $0.11
Revenue $88.9 million $91.0 million

Earnings per share grew to $0.11 from $0.01, and revenue rose 15.4% year over year; comparable-restaurant sales increased 2.4%. These may seem like solid numbers, but they were not enough to satisfy investors. The stock declined 9.8% after the report, from $46.66 to $42.10, and things got worse when the company announced a secondary offering of 4.5 million shares at the price of $39.50 on Dec. 5, 2013. Noodles has fallen more than 24% since reporting and now sits more than 31% below its 52-week high, which is below the closing price on the day of its IPO. This leaves investors wondering if now is the time to buy or if the decline will persist.

Should we buy?
After reviewing the earnings reports and reasons for the declines, Potbelly is the only one investors should consider for investment. Noodles' report was not bad, but I strongly dislike how the company proceeded to do a secondary offering during a massive sell off; I believe it should have held off and waited for the stock to regain strength to go on with the secondary.

In terms of valuation, both companies trade at more than 60 times 2014's earnings estimates, so it would be smart to wait for the next round of earnings reports to come out before making any investments; the companies will give updated outlooks, and I believe those will be the key to sending the stocks higher.

The Foolish bottom line
Potbelly and Noodles were two of the hottest IPOs in 2013. After strong runs, both fell from glory quickly and now sit below the levels reached in the first days of trading. Potbelly is the better investment opportunity of the two, but I would wait for the next earnings report to come out before putting your money to work. If it can deliver on earnings and guidance, Potbelly could easily outperform the overall market and be a top performer in the restaurant industry.

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Joseph Solitro

A fan of innovation, strong fundamentals, and all things baseball. Follow on Twitter @JoeySolitro. Fool on!

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