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The Potbelly Stock Pullback Is Actually A Good Thing

Jon C. Ogg

Potbelly Corporation (PBPB) was among the hottest of the hot IPOs of 2013 when you count first day gains as a public company. The problem is that the sandwich chain became too hot to handle for new investors. Barron's recently couldn't help but call the stock grossly overvalued and that helped send shares south amid more government shutdown and debt ceiling debate uncertainty. We felt the stock was overvalued too, but this pullback is something that we would call a really good thing.

If you have been to a Potbelly sandwich shop there is one thing you probably know. The sandwiches are great, but we would always admit and warn any investors that no one should simply just buy a stock just because you like their products. Still, repeat traffic is high, market penetration is very low in many geographies, and some major geographic gaps exits entirely. We also have hears that complaints are few and far between compared to other casual dining and fast food (or relatively fast food) chains, at least according to diners and from insiders.

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So, why is a falling share price a good thing?

For starters, people who buy an IPO up 100% and hope that the price will just keep rising are not exactly going to be the most loyal shareholders in the world. We even think Barron's was right that the stock was overvalued, but we have an issue with how low they put the perceived valuation as being back closer to the IPO price of $14.00.

Our take is that when an IPO of a semi-national retail or restaurant chain doubles in price out of the chute then it is usually the underwriters who got the IPO so wrong. That is not enough to prevent a gap and crap trade, where share trade higher out of the chute only to crater in price. If you have followed Potbelly shares the trading has been ugly since the IPO. Still, Potbelly being evaluated at $14 by Barron's sure seems like more of a Nervous Nelly evaluation than it is a bull market valuation.

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We mentioned in our pre-IPO analysis that Potbelly's initial IPO price range did not seem aggressive at all. We also praised their sandwiches, but again that is not the only reason to buy an IPO. What is obvious is that Potbelly has major growth opportunities in the decade ahead, and that is where "the Barron's bash" from this last weekend is simply grossly overstated by our take. In fact, it would not be surprising to us at all to see twice as many Potbelly stores by 2020 as there are in late 2013. We would disclose that this projection is far more aggressive than some would call for but that is what makes a ballgame.

Can you blame the Potbelly drop on market uncertainty? Perhaps, but we would point out that shares were falling last week even when the markets rallied on hopes to a resolution in Washington D.C. about the government shutdown and debt ceiling. We said that trading was poor already, but Potbelly shares have traded up on only one trading day since the IPO and that was by a mere 1% or so.

The true logic behind the rationale that a selloff in this stock is good is because this pullback will ultimately allow a much stronger shareholder base to form. Getting strong institutional investors and individual investors to hold through good times and bad times at 75-times to 125-times earnings is asking too much. Today's $25 or so price after yet another 4% drop may not even be the bottom, and frankly the price action of the stock is not indicating that any bottom has been found at all.

Shares hit a post-IPO low of $23.77 on Tuesday against post-IPO high of $33.90. Yes, that is a drop of over $10 from peak to trough. We still argue that this is a good thing for investors who want to own a piece of this great restaurant chain at lower prices.

We doubt that Potbelly is headed back to $14 as Barron's suggested, even if it is 114-times trailing earnings. Anything is possible, but from an outsider's view we think that anything under $20 will start to entice a better base of shareholders. We are probably going to refrain from covering Potbelly too much until the dust settles in the days or weeks ahead. The IPO after-market sometimes acts as crazy as hot IPOs but in reverse order.

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Another warning is that there are the IPO-lockup shares that will come out in a few months as well. That will likely bring up another round of weakness, but will still likely allow an even better entry point for long-term holders. Calling a sell-off a good thing sounds counterintuitive when you consider that someone is likely losing money, but the people who are losing money in Potbelly at the current time are the ones who were only looking to make a quick buck in the first place.

This stock may still sell off further, but it will likely be a good thing for the long-term investors who recognize the value when the dust settles.

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