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Should McDonald's Buy Shake Shack?

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Shares of Shake Shack (SHAK - Free Report) have been on a great run recently and the stock has gained nearly 10% in just the last four weeks. After a rough start to the year, this recent trading activity has been a welcome change for the often-volatile fast-casual burger chain.

The volatility that comes with Shake Shack stems from investors that trade the stock based on hype rather than its actual metrics. Even still, the company has consistently posted strong growth numbers and should inevitably catch up to that hype.

What’s most interesting about Shake Shack is that, even though the chain has less than 100 stores worldwide, it is already a recognizable brand name in the restaurant industry. A new option that claims to offer better tasting, higher-quality food tends to throw a wrench in the operations of the established industry leaders.

In the burger world, there is no bigger name than McDonald’s (MCD - Free Report) . While Shake Shack is not yet big enough to be running McDonald’s out of business, it certainly has the ability to steal some customers who are hungry for a hamburger. In other words, it’s safe to say that McDonald’s is well aware of Shake Shack and must look for ways to overcome this new challenge.

One way that industry giants often combat new competition is to simply eliminate the competitive element by buying that company while it’s still young. Scooping up Shake Shack at this point would be an undeniably powerful move for McDonald’s, but that doesn’t necessarily mean it is the smartest idea. Let’s take a closer look.

Growth vs. Value

To begin this conversation we need to look at what is working for both of these companies. For Shake Shack, as mentioned before, it’s the company’s ability to consistently grow the brand. At the end of last quarter, there were 88 Shake Shacks in operation, up 22 from a year before.

The ability to open new stores helped Shake Shack post revenue growth of nearly 44% on a year-over-year basis. Even “same-Shack” sales growth came in at an impressive 9.90%.

Part of Shake Shack’s success in growing the brand has been that its stores are proving to be much more dynamic than many expected. The company quickly expanded outside of its typical storefront locations and has opened or is planning to open restaurants in airports, public transportation hubs, and even the Mall of America.

On the other end of the spectrum is McDonald’s, where growth has basically stalled. In 2015, the company saw comparable-store sales growth of just 1.5%, and in its latest quarter McDonald’s reported a 1% year-over-year decline in revenue. Also, from 4Q15 to 1Q16, McDonald’s saw a net decline of 58 restaurants worldwide.

Of course, for one of the biggest restaurant brands in the world, storefront and revenue growth aren’t necessarily the most important factors. McDonald’s has still been able to grow earnings, and we can’t expect it to be opening new stores at the same rate of a growing company like Shake Shack.

In short, we would expect Shake Shack to be out-pacing McDonald’s in the key growth categories right now. Anything else would be underwhelming. However, when we talk about whether buying Shake Shack would be a good move by McDonald’s, we need to look at the value metrics.

Right now, Shake Shack as a P/E ratio of 87.92, a P/S ratio of 4.07, and a PEG Ratio of 3.49. These lackluster scores have earned the company a Value grade of “F” in our Style Scores system. Its market cap stands at about $860 million, and it just doesn’t seem like that price tag matches what McDonald’s gets out of the brand right now.

Bottom Line

The hype that I mentioned earlier is what plagues Shake Shack in these situations. While the stock has proven that it can make month-long runs of impressive gains, it remains incredibly volatile as investors continue to trade on daily news and future valuations instead of today’s metrics.

For a lot of companies in a similar position to Shake Shack, this ends up working out. The stock may rise and dip uncontrollably for a while, but if the company continues to grow, the revenues and earnings will eventually catch up. However, from the prospective of a potential buyer, this hype makes the company overvalued at the moment.

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