Shareholders of The ONE Group would probably like to forget the past six months even happened. The stock dropped 56.7% and now trades at $1.86. This was partly driven by its softer quarterly results and may have investors wondering how to approach the situation.

Is there a buying opportunity in The ONE Group, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free for active Edge members.

Why Do We Think The ONE Group Will Underperform?

Despite the more favorable entry price, we're cautious about The ONE Group. Here are three reasons we avoid STKS and a stock we'd rather own.

1. Shrinking Same-Store Sales Indicate Waning Demand

Same-store sales show the change in sales at restaurants open for at least a year. This is a key performance indicator because it measures organic growth.

The ONE Group’s demand has been shrinking over the last two years as its same-store sales have averaged 3.5% annual declines.

2. EPS Trending Down

Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.

Sadly for The ONE Group, its EPS declined by 54.6% annually over the last six years while its revenue grew by 43.4%. This tells us the company became less profitable on a per-share basis as it expanded.

3. High Debt Levels Increase Risk

As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.

The ONE Group’s $632.9 million of debt exceeds the $6.05 million of cash on its balance sheet. Furthermore, its 7× net-debt-to-EBITDA ratio (based on its EBITDA of $89.4 million over the last 12 months) shows the company is overleveraged.

At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. The ONE Group could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.

We hope The ONE Group can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.

Final Judgment

The ONE Group falls short of our quality standards. After the recent drawdown, the stock trades at 4.1× forward P/E (or $1.86 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are better stocks to buy right now. Let us point you toward one of Charlie Munger’s all-time favorite businesses.

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