To say that investors have a big appetite for Cava Group's (CAVA 2.07%) stock would be an understatement. As of July 19, shares are up more than 100% compared to their opening price on the first day of trading on June 15.
For investors in this restaurant stock, the hope is that its fast growth can continue for years to come. Given enough time, shareholders would love it if Cava could become the next Chipotle Mexican Grill, the popular Tex-Mex chain that has been thriving for several years now, and still has tremendous growth potential.
But I think it's important not to forget that this is still a restaurant business. And this presents a key risk that's strikingly obvious. Here's what investors should know.
Looking at the industry
Investors seeking stocks for the long haul should choose businesses with some sort of competitive advantage. This not only helps a company fend off its rivals in the industry, but also might discourage upstarts from entering the market.
And it helps generate better financial performance. Legendary investor Warren Buffett prioritizes competitive advantages when adding stocks to Berkshire Hathaway's portfolio.
When it comes to restaurant businesses, it's more difficult to find this kind of favorable attribute. That's mainly because the competition is so incredibly high. Consumers experience this daily.
There are grocery stores, like Walmart or Kroger, for those looking to prepare their own meals. There are also high-end restaurants, as well as other fast-casual and fast-food chains. All of them are constantly battling for consumers' wallet share.
More specifically, Cava goes up against other fast-casual Mediterranean options, like Naf Naf Middle Eastern Grill, Papa Gyros, and Aladdin's Eatery. And these are options just in my local market. There are a huge number of choices all across the country, from independent mom-and-pop joints to multiple-location chains.
This presents a huge challenge for a company like Cava. There is a ridiculous amount of competition, in both existing markets and new ones, that will never really go away, which will make it harder to execute on management's growth outlook. After all, this growth potential is exactly why investors are attracted to the stock in the first place. But it's not a sure thing.
Cava will have to continuously invest resources into bringing on talented labor, as well as spending money on marketing initiatives. And the business will always be competing for prime real estate to open new locations. These issues could place a lid on Cava's long-term profit potential.
That's why I view the competitive landscape as the company's biggest risk, and perhaps a reason to remain cautious.
Should you buy Cava shares?
Despite this important risk, investors are still in love with Cava's growth prospects, which is what its entire thesis centers on. Revenue in the first quarter totaled $197 million, up 76% year over year. The business currently has 263 stores, up from just 22 at the end of 2016. And same-store sales, a crucial metric for retail-based operations, have risen at a remarkable clip.
Cava also has a meaningful omnichannel presence, with digital sales increasing 51% year over year in 2022. These customers spend more than the average customer. The chain also has 3.7 million loyalty members.
Management thinks that by 2032, the company can have at least 1,000 locations across the United States, which would be roughly 300% bigger than the current footprint. And at this scale, it's easy to see how the business would be able to leverage its fixed costs to produce positive net income.
The promise of outsize growth, coupled with the possibility of achieving positive net income, might be enough to persuade investors to buy the stock. But it's also important to consider the valuation. After its quick run-up, shares of Cava trade at a price-to-sales (P/S) ratio of approximately 10 right now.
That shows that the stock might be priced for perfection. Investors who care less about the expensive valuation might still consider buying shares, though.
