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Shake Shack Stock Is Shaken, But You Don’t Have to Avoid It

Nicolas Chahine

Shake Shack (NYSE:SHAK) management reported earnings last night and markets were not happy with what they saw. The stock had an initial spike on the report card itself, but then quickly turned red. It wasn’t that they failed to meet their goals — in fact, SHAK exceeded expectations on sales and profitability metrics — but as is the case so often these days, investors hated on their forward guidance.

SHAK Stock: Shake Shack Stock Is Shaken, But You Don't Have to Avoid It

Source: Mike Mozart via Flickr (modified)

Therein lay the problem for SHAK stock. They disappointed the markets last night with their overly cautious estimates for the year. They promised comparable sales of zero to 1%. This is definitely not what gets people excited about the stock; hence the selling now.

When traders pay up in premium for a growth restaurant company, they expect strong growth. Otherwise they would punish the ticker.

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There are exceptions to this when management cites a specific temporary reason for the dip in comps. Then investors could give them a one-time pass, but they have not yet done so in the case of SHAK stock.

This is a high-valuation stock, selling at a 72x forward price-to-earnings ratio. And the only reason Wall Street allows it to be this high is its aggressive growth trajectory or the promise of one. At these levels, it is in the same valuation league as Chipotle (NYSE:CMG) and Amazon (NASDAQ:AMZN) and those two have earned their stripes with years of history to command high props. Don’t get me wrong I dislike both restaurant from that perspective but at least CMG is more mature about it.

Yesterday, SHAK management pretty much told Wall Street that its sees no comparable growth in sales and the stock would be a snooze-fest this year. Traders are right to immediately punish it. But there is a difference between what investors do versus what speculators do. Neither is more right than the other, they’re just two different styles of trading with a different thesis.

Those who believe in the long-term viability of Shake Shack need not fret short-term dips like this one for as long as their thesis is still viable. I am not one of them because for that kind of valuation, I’d rather be long AMZN. So at best, I could trade it short-term. For that, I set aside much of the fundamentals and look to the charts for guidance to snipe important levels.

Year-to-date, SHAK stock is up in line with the S&P 500, so it’s not a disaster to see it fall 2% this morning.

From the daily charts, although it has had a few good weeks of price action, it has been in a down trade since the double top last June. Since then, the stock slid as much as 40% from high to low. Luckily, traders emphatically rejected the Christmas lows.

Shorter term, this dip merely brings it back into a pivot zone so the bulls can solidify it as support for future upside. The onus is on the bears to sustain the selling to break below it.

How to Trade SHAK Stock

For trading purposes, it’s best to go more granular and highlight the fact that $50 per share is a two month pivot so it should be support zone one. If it fails then $48.20 would be the next level of support. It’s the short-term point of control where bulls and bears agree on value. These tend to be solid footing on the way down because both sides will fight it out hard, thereby creating congestion.

It is strong support zone like this that make for good entry points for mid-term traders. If I wanted to trade it more short term then I could enter more aggressively around $50 per share. Exit points are as important as entries. If the stock bounces back from this earnings dip then I’d exit the short term bets as it nears $52.70. The same logic applies on the way up. When prices approach prior fail ledges then there would be a supply of sellers waiting.

Stop-loss levels are also important for the short-term traders. In this case if the selling persists then there is another pivot level around $46.30 per share which is about the lower end of the value area so far this year. There are more granular levels in between those, and $47.35 is one. That would make a good stop loss for me because below it there is a bit of open air which makes for a magnetic effect to the value area lows.

In short, long-term I am not a fan of chasing high-valuation restaurant stocks. So like CMG, I regard SHAK stock as too expensive to own given all the headwinds they face. Wall Street experts disagree with me because plenty of analysts rate it as a “buy” and it is only trading at their average price targets.

To me, the biggest expense for operators’ P&L is usually labor and that is a big problem these days when the U.S. is at full employment.  Evidence of it is that the U.S. Federal reserve listed as the biggest inflation issue. While the CPI is failing to measure actual product inflation, the services definitely exhibit the symptoms. So restaurants will suffer for a while there.

Meanwhile, I would trade it short term while sticking to proper price levels.

Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on Twitter and Stocktwits.

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