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Cava's Stock Hasn't Been This Low Since Its IPO: Time to Buy the Dip?

Motley Fool - Wed Sep 20, 4:35AM CDT

Cava Group (NYSE: CAVA) was a hot stock when it first began trading in June. The excitement around its growth and the potential for the Mediterranean-style restaurant chain to be the next Chipotle Mexican Grill sent investors into a frenzy. On Aug. 2, the stock price reached a high of $58.10 -- 52% higher than the $38.15 it closed at on its first day. But the stock has given back those gains, and as of Monday's close, it hit a new low of $34.13.

Is this a case of an inflated stock simply coming back down to reality, or is this a business that's in trouble and whose valuation is likely heading further down in value?

Wall Street thinks it's a deal

According to the consensus analyst price target of nearly $50, the upside for the restaurant stock could be more than 40% from where it trades today. Even the lowest price target of $40 would suggest the stock is a good buy today.

The risk with relying too heavily on analyst price targets is that they can and do change over time. As economic conditions change and the company reports earnings, analysts will update where they expect a stock to go. Their price targets are also based on how they expect the stock will perform over the next 12 months or so.

Why the stock could rally

What has drawn investors to Cava's stock is the exciting growth numbers it generates. For the quarter ending July 2, Cava's revenue of $171.1 million was up an impressive 62% year over year. The company's same-restaurant sales growth rate was also high at over 18%.

The key to Cava being able to rally is to continue to grow at high rates. Although it projects its same-restaurant sales growth to be between 13% and 15% this year (suggesting a bit of a slowdown), that's still better than many restaurant businesses out there. Chipotle, by comparison, reported comparable restaurant sales growth of only 7% in its most recent quarterly results (they ended on June 30).

Why Cava's stock might struggle

The challenge for Cava moving forward is that investors may expect to see not only strong revenue growth but higher profits as well. And with the company's revenue growth looking like it might slow down, combined with potentially worsening economic conditions, that could be a recipe for trouble for the food stock. While Cava may still generate double-digit sales growth, profitability may not be a sure thing. Its profit margin was less than 4% of revenue last quarter.

Investors are also growing increasingly bearish on the company, as short interest as a percentage of Cava's float is up to almost 8%.

CAVA Percent of Float Short Chart

CAVA Percent of Float Short data by YCharts

If the company's next quarterly results show a steep slowdown in sales growth or a worsening bottom line, the short interest may rise. And when there's an uptick in people shorting a stock, that leads to more downward pressure on the price.

Should you buy Cava's stock?

Cava could make for an intriguing buy because previously the problem with the stock was primarily its high valuation. The business doesn't look broken by any means, nor does it appear to be in trouble. The company is achieving promising growth, and even if it does slow down a bit it could still make for a good buy given its growth opportunities.

If you are OK with the risk, this could be worth picking up and adding to your portfolio. But for risk-averse investors, the safer approach is to wait and see how the company does over the next quarter or two to see just how resilient Cava's growth rate proves to be, and whether its profits are sustainable.

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David Jagielski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chipotle Mexican Grill. The Motley Fool has a disclosure policy.

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