What happened
Shares of Cava Group (CAVA 10.50%) dropped 32% in September, according to data provided by S&P Global Market Intelligence. There wasn't any specific news on the newly public company, but hot initial public offering (IPO) stocks often begin to fall after early surges if their valuations become inflated.
So what
Cava was one of the first IPOs this year to catch investor attention, and is still one of the only ones. Last year's bear market ended a streak of IPO fever partly sparked by the emergence of the special purpose acquisition company (SPAC) and a strong, yearslong bear market.
Cava operates a fast-casual restaurant chain focused on midprice Mediterranean fare, and it has been demonstrating impressive growth. It has only 279 restaurants and has a long growth runway in opening new units, in itself a growth driver.
But it has also been posting robust comparable-restaurant (comps) sales figures, which indicates that customers like what they're getting. Revenue increased 62% year over year in the second quarter, fueled by an 18% increase in comps.
Making more money from each store is also contributing to profitability, since many of the costs are fixed, and more sales go to the bottom line. While Cava wasn't profitable at its IPO in June, it has already posted a profit in its first quarterly report as a public company, with $6.5 million in net income after an $8.2 million loss last year.
Considering what looks like incredible potential and a dearth of great IPO stocks to invest in, Cava stock soared when it went public in June, rising 30% from its first-day closing price through the end of July.
Now what
IPOs are generally risky for a variety of reasons. One is the simple fact that new stocks are unknown. Another is that prices for hot IPOs often surge due to hype and then fall back, which is what's happening to Cava right now.
Also, IPO stocks often fall after the end of the lockup period, when insiders can begin to sell their shares, and it's usually a good idea to wait until that period ends to buy an IPO even when it looks like it has excellent long-term prospects.
At the current price, Cava trades at 4.4 times trailing-12-month sales, which is inexpensive for a growth stock. But its slide might not be over yet, and in any case, investors should wait for more positive earnings reports before deciding to buy the stock.
