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Bear of the Day: Jack in the Box (JACK)

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U.S. stocks on Monday gained back about a third of what they lost during the volatile Thanksgiving week, but it is certainly too early to say whether this is the start of an extended rebound—or simply a brief rally that will be met with continued selling.

There are plenty of headwinds forcing stocks lower right now, including concerns about rising interest rates and a global economic slowdown. It makes sense to avoid companies most exposed to these headwinds. Wall Street has also punished high-flying growth and momentum stocks recently, as renewed caution—and in some case, poor guidance—pressured investors to take profits and move into more defensive positions.

With that said, it still feels difficult to predict what is coming on any given day, or even what direction we are heading over the next few months. This means investors should also avoid stocks that show one specific trait likely to result in near-term volatility in all types of market environment—those with rising share prices and falling earnings outlooks. One such example is restaurant chain Jack in the Box (JACK - Free Report) .

Jack in the Box is a quick-service hamburger chain based in San Diego, California. The company’s system includes more than 2,000 restaurants throughout many states. It previously operated fast-casual Mexican chain Qdoba but sold that segment to public equity firm Apollo Global Management (APO - Free Report) earlier this year.

The key reason why Jack in the Box is troublesome right now is that its forward-looking earnings outlook does not match its recent share price trend, and that divergence is likely to correct itself soon. The relationship between share prices and earnings trends does not always play out immediately, but over time the two indicators do tend to mirror each other. To get a sense of the problem with JACK right now, we must start with its latest earnings report.

Jack in the Box released its most recent quarterly earnings report on November 19. The burger chain posted adjusted earnings of $0.77 per share, missing the Zacks Consensus Estimate of 83 cents. Revenues were down 23.5% on a year-over-year basis to $177.5 million due to the Qdoba divesture—although these results did edge out estimates of $174 million.

Shares of JACK surged after this report, as investors appreciated the company’s comps growth of 0.5% and guidance of 0% to 2% comps growth in 2019. The stock has added about 10% since the report was posted.

But there are some reasons not to love this trend. First, this comps growth is less impressive when one considers that the 0.5% improvement compares to a year-ago quarter which saw JACK report a system-wide comps decline of 1%. Moreover, Jack in the Box’s comps guidance did not come with a strong outlook for earnings in 2019.

JACK did not issue guidance for adjusted EPS specifically, but its expectations for adjusted EBITDA were enough to get analysts working on their own estimate revisions. Here’s what has happened to analyst expectations since the guidance was published:

As we can see, analysts have been busy revising their estimates for Jack in the Box’s current fiscal year downward. This has been a universally-negative trend among revising analysts, and it has taken quite the bite out of Jack in the Box’s Zacks Consensus Estimate for earnings.

This is the troublesome trend described above. Hopeful investors can spark positive short-term price movements when certain items are interpreted positively, but over time, we expect JACK shares to reflect the negative trend in the company’s earnings estimates.

Another thing to note here is that this type of divergence stretches a company’s P/E to the point where its valuation case starts to fade. Here we can see that JACK is now trading at over 20x forward 12-month earnings, which is near a six-month high for the stock:

This 20x valuation is still a slight discount compared to its peer group’s average of nearly 23x, but we have to ask ourselves whether this earnings multiple is justified if comparable restaurant chains present us with a more favorable earnings outlook.

For instance, Papa Murphy’s (FRSH - Free Report) is currently a Zacks Rank #1 (Strong Buy) with a Forward P/E of just 11, while Darden Restaurants (DRI - Free Report) has a Zacks Rank #2 (Buy) and a Forward P/E of 19.

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