Shares of Mediterranean fast-casual restaurant chain Cava(NYSE: CAVA) soared 35.4% during August, according to data provided by S&P Global Market Intelligence. Strong financial results for second-quarter 2024 and a corresponding enthusiastic response from Wall Street boosted the stock to an all-time high. But a subsequent stock sale caused a modest pullback.
On Aug. 22, Cava reported Q2 financial results, and it was all good news for shareholders. Its Q2 revenue was up an astounding 35% from the same quarter of 2023. It also turned in its highest quarterly profit margin ever at 8.5%.
There were other high points in the Q2 report as well. With strong financial results, Wall Street sang Cava's praises. Many analysts increased their price targets for the stock -- in other words, after looking at the numbers, these investing professionals decided the upside is higher than they previously thought. This boosted general investor sentiment.
However, something late in the month threw a little cold water on all this. Several insiders sold shares, including co-founder and CEO Brett Schulman, who sold about 200,000 shares on Aug. 26. When insiders sell, it can indicate that the stock is overvalued, and it's why Cava stock pulled back from its all-time high.
Is this a problem for Cava?
I wouldn't necessarily push the panic button if I were a Cava shareholder. For founders, growing a business and taking it public is quite the journey. Moreover, it can a be low-income journey. Therefore, it's understandable that insiders might cash in on some shares and finally reap some of the reward of the business' success.
That said, insiders don't seem to sell as much when a stock is undervalued. And investors might already be a little jumpy when it comes to Cava's valuation. As of this writing, it trades at 16 times sales.
CAVA PS Ratio data by YCharts.
That's not necessarily unheard of for a restaurant stock. But it's unusual for a company like Cava, which uses a company-owned model instead of a franchised model. Moreover, all the company's restaurant's locations are leased -- it doesn't own real estate. By not even owning real estate, one would expect a lower valuation for Cava than what it fetches right now.
What should investors do now?
In my opinion, Cava is both a great business and an overvalued stock. These two realities could motivate different responses for different investors.
For investors who might have already been planning to sell Cava stock in 2024, I think today's valuation offers a great price.
For investors with no intention of selling, Cava is still a great business, and Q2 proved it more than ever. And the more time a quality business has, the less valuation tends to matter. Understand that the stock could underperform for a time if its valuation drops in the near term. But if Cava keeps executing as it has, it can grow past its valuation risk.
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Jon Quast has no position in any of the stocks mentioned. The Motley Fool recommends Cava Group. The Motley Fool has a disclosure policy.
