I don’t believe business is as good as the stock prices would suggest.
The first half of 2024 is already in the books, and the S&P 500 is up almost 16%. Statistically speaking, this puts the market on pace for one of its best yearly performances ever. But this doesn’t hold a candle to returns for shares of restaurant company Sweetgreen (SG -2.89%), egg business Vital Farms (VITL -1.98%), or apparel retailer Abercrombie & Fitch (ANF -4.57%).
These three stocks have all doubled or more since the beginning of the year, leaving the S&P 500 in the dust. Indeed, this trio has performed better than most publicly traded companies so far this year.
SG data by YCharts
However, it’s possible for stocks to become overheated in the short term and subsequently pull back to more reasonable prices. And I think that this could happen for Sweetgreen, Vital Farms, and Abercrombie & Fitch from here. Here’s why.
Can Sweetgreen turn a profit?
Sweetgreen is one of the best salad restaurant chains out there. But unfortunately, I don’t believe that this is a concept that can scale profitably. From my perspective, this chain does well in dense, urban areas, but it struggles to do as well as it moves into more suburban areas.
To back up my belief, consider that the average Sweetgreen location had nearly $3 million in average annual sales volume in 2019. And in that year, 39% of revenue came just from locations in New York City, to say nothing of locations in Los Angeles and San Francisco.
However, by the first quarter of 2024, Sweetgreen’s average unit volume had dropped to just $2.9 million. In other words, the company opened many new locations over the last several years, and same-store sales consistently increased. But the newer locations appear to have a lower starting point for sales compared to the established locations in more urban settings.
Higher sales volume typically results in better profits for restaurant stocks. Sales volume for Sweetgreen is already pretty good compared to its peers, but it’s still a long ways from profitable. And since sales volume for newer locations doesn’t seem to be as good, the situation hasn’t improved with scale.
SG Revenue (TTM) data by YCharts
Sweetgreen stock has gotten quite pricey after its 150% gain over the last six months. I have questions about its long-term prospects. And for this reason, I wouldn’t be surprised if the stock pulled back in the second half of the year.
Vital Farms is more than generously valued
Most people who raise backyard chickens agree: Pasture-raised eggs are better than eggs produced from chickens in cages, which is why Vital Farms opted for the pasture-raised business model. The company does have other products as well. But 97% of its revenue in the first quarter of 2024 was from eggs and egg-related products. And about 80% of its eggs are pasture-raised, according to management.
However, there’s a reason that few companies do what Vital Farms is doing: Raising chickens on pasture is more expensive. The company consequently charges premium prices for its eggs to cover its higher costs.
Don’t misunderstand: There are clearly consumers who want this. In Q1, net revenue for Vital Farms was up 24% year over year, mostly thanks to higher sales volume. And the company was able to turn a Q1 net profit of $19 million, which represents a stellar profit margin of almost 13%.
Vital Farms has a lot to like. But from an investment perspective, the valuation is extreme for an egg business, at more than 50 times its trailing earnings.
From the end of 2023 through the end of 2027, management hopes to double its revenue. Assuming it achieves its goal and maintains its stellar profit margin, the stock already trades at 25 times its potential earnings in 2027, which is much higher than comparable businesses.
VITL PE Ratio data by YCharts
One could make the argument that Vital Farms stock needs a pullback to be reasonably valued. But at the very least, it’s due for a breather after its 180% gain in the first half of the year. And longer term, I believe it’s fair to question just how many consumers are willing to pay higher prices for higher-quality eggs.
Will Abercrombie & Fitch sustain its suddenly stellar growth?
For Abercrombie & Fitch shareholders, there’s one chart that must be examined. Right now, the stock trades at more than 2 times its trailing sales, its highest level in nearly 20 years — that’s shocking.
ANF PS Ratio data by YCharts
I’ll happily give Abercrombie & Fitch a lot of credit. The company started targeting adults instead of teens, recapturing an audience that left the brand after it grew up. The move appears to have worked flawlessly, considering net sales in the first quarter of 2024 were record-breaking. And the surge in sales led to an impressive profit margin of 11%.
That said, Abercrombie & Fitch’s Q1 net sales were up 22% year over year, almost entirely thanks to higher same-store sales. That’s good. But it’s a reminder that this isn’t a company that’s growing by opening new stores or by expanding into new markets. Because of this, I don’t expect sales to keep growing at such an impressive pace — there’s a limit to a same-store-sales boom.
Fashion trends can change on a dime. And apparel retailers are notorious for overestimating demand, eventually leaving them with outdated inventory. Therefore, it could be a good time to take some profits off of the table with Abercrombie & Fitch stock before its fortunes change, especially considering the valuation is now historically high.
As a reminder, investors shouldn’t sell stocks simply because they have big gains. Holding on to winners is an excellent path to superior returns. For shareholders who have a much higher opinion than mine about the long-term prospects of Sweetgreen, Vital Farms, or Abercrombie & Fitch, the best option would likely be to keep holding. But for me, I’ve laid out the reasons why I question how sustainable returns will be for this trio in the back half of the year.