Investors seem to love new stocks. Wall Street routinely sends stocks soaring when companies initiate their initial public offerings (IPOs). The most recent example is the restaurant chain Cava Group (CAVA 4.89%).
Cava is described by some as a Mediterranean food version of Tex-Mex fast-casual restaurant chain Chipotle Mexican Grill. Investors hope this relatively new restaurant competitor can be as successful as Chipotle as a restaurant and as a stock. Chipotle stock appreciated in value enormously since it went public.
If you are considering this new stock opportunity, you might want to take a moment to think things through before rushing to add Cava Group to your portfolio. IPO stocks often experience buying frenzies at their public debuts, only to fall significantly in the months after.
Cava is riding the IPO hype train
IPO stocks are like Wall Street's shiny toys. Everyone wants to be able to say they bought and held some stock from its IPO to massive gains years later. But what even is an IPO? In an initial public offering, a company sells shares in the public markets for the first time. Businesses typically hire investment banks to manage the process and gauge what the public might pay for those shares. The primary goals of IPOs are to raise money to help fund the company's growth and to allow earlier stakeholders to take profits from their investments.
Cava Group ultimately priced its IPO at $22 per share. Since the IPO, shares have ballooned to more than $47, which suggests that the company may have left money on the table by not setting the IPO price higher initially.
Regardless of where it trades today though, Cava's leadership team must have felt that $22 was a fair price for a share of stock. Otherwise, it probably would've charged more.
So why did Cava's stock price jump so much? It might have something to do with Chipotle's success as a public company. That stock has risen by more than 4,500% since the burrito chain went public in 2006. Cava has a similar model to Chipotle. They're both hybrids, straddling the line between offering fast food and fresh food. Customers can pick from many ingredients prepared onsite to build their meals. And investors who missed out on Chipotle's share price gains could be looking for the next Chipotle.
Why Cava might fall over the coming months
Many things can drive share prices higher or lower in the short term, but fundamentals tend to determine a stock's long-term performance. In Cava's case, there is a real threat that the gravity of valuation metrics will eventually pull the stock lower again.
Companies prefer to go public when the stock market is rising because broad investor optimism can help them get a higher price for their shares. Cava IPO'd amid a six-month rally in the broader market.
Investors should look at the company's valuation to get an indication of whether the stock is likely to be able to maintain its recent momentum. Cava Group isn't profitable yet, so investors can't weigh its value relative to its (nonexistent) earnings. Right now, analysts' consensus estimates are that its earnings per share will turn positive in 2026.
If you gauge the company based on revenue, you can at least compare it to Chipotle, a fairly reasonable comparison. Today, Chipotle might be considered an expensive stock. It trades at a price-to-sales ratio of 5.7 against estimated 2023 revenue. Meanwhile, Cava trades at a price-to-sales ratio of 7.6 against its 2023 estimate.
What should investors do?
Chipotle is very profitable and is still growing at a pretty solid pace. Does Cava deserve to trade at a notable premium to Chipotle -- which, again, is arguably expensive? It's tough to justify answering that question with a "yes," which is why it appears the odds are more in favor of the stock pulling back than in favor of it continuing to defy gravity.
Cava is a new and exciting stock, but those don't always make sound investments. The company must now put up some solid operating numbers and have its results examined under the bright spotlight of the public markets. Investors shouldn't necessarily sell Cava shares if they own them, but those looking to accumulate them now should consider starting with a tiny position and adding to it slowly.