A brand-new Shake Shack (NYSE:SHAK) opened in Orlando this morning. It's several miles away from the Magic Kingdom, but in the eyes of some naysayers, it may as well have opened in Fantasyland.
Shake Shack is one of this year's most successful IPOs, soaring 165% since going public in January at $21 as of yesterday's close. It's also been one of the most volatile debutantes. Anything from a chicken-themed trademark application to insider sales can send the stock on a wild move up or down.
Shake Shack has become a fiercely contested battleground stock, and even though the bears think the stock is insanely overvalued, let's go over the one thing that skeptics can't seem to calculate correctly.
No one gets the market value-per-restaurant metric right
A popular bear move when the stock was hitting its springtime peak was to divide Shake Shack's market cap by the number of restaurants to arrive at the value that the market was placing on the average location. This made waves when the average Shack topped $50 million in market value, several times more than its burger-flipping peers, and everyone began working the same math as if it made any sense.
Let's make one thing clear: Shack Shack -- like most chains -- consists of both company-owned and franchised locations. Just 37 of the 71 units open as of July 1 were owned and operated by Shake Shack. There are 29 licensed locations overseas and another five that are licensed closer to home. There's a huge difference on the top line and a material one on the bottom line between running a restaurant and merely collecting franchise fees and royalties.
Bears may be drooling at blowing this. If we divide Shake Shack's current market cap by just 37 company-owned units, that figure grows even larger. Wait. There's more. There seems to be a lot of confusion about how to figure out Shake Shack's market cap. There are two classes of shares and using the average weighted shares found in income statements understates the number by weighting post-IPO shares and not including all of the class A shares. I'll save you the suspense. According to the latest SEC filing, there were a combined 36.2 million shares outstanding as of August 5.
That results in Shake Shack checking in with a market cap of just over $2 billion as of Tuesday's close. Divide that by 37 company-operated eateries and we get an average of $54.5 million per location. That's higher than the bears thought back when the stock was trading much higher a few months ago, but you didn't think I'd build up the naysayer argument without pulling the rug from under it, did you?
The worst offense is to compare that metric to other chains as if we're comparing apples to apples -- or patties to patties. I'm not pointing fingers. Everyone's been doing it, and that includes some of my fellow Fools. It just doesn't make sense. Who cares if Wendy's is only valued at $462,000 per restaurant? That's a chain that's primarily franchisee-owned, and it's in the process of handing over even more company-owned eateries until it owns just 5% of the total. McDonald's is at just 10% company-owned for its domestic units, and Burger King is at 0%. The math doesn't work out the way you think it will when pitted against Shake Shack, which owns more than half of its restaurants.
We also can't assume that every unit is equal. The average Shack Shack generates roughly $5 million in annual sales, twice as much as your typical Mickey D's and more than three times what Wendy's is averaging. Judging by Shake Shack's 12.9% spike in comps in its most recent quarter with larger burger flippers barely keeping pace with inflation, the disparity could be widening.
Shake Shack is also committed to opening at least a dozen company-owned eateries a year. That's a lot of growth off its current base of 37 eateries, substantially juicing up the denomination in the metric's equation. So get it right, bears: There are some valid arguments out there to be made about the stock's lofty valuation, but stop repeating a misleading, if not inaccurate, metric. Bulls and bears deserve better than that.