Restaurants increase convenience and give many people a place to unwind. Still, their demand can ebb and flow with the broader economy because consumers can always cook meals at home when times are tough, and the market seems to be baking in a downturn for the industry - over the past six months, it has pulled back by 6.6%. This performance was worse than the S&P 500’s 2.3% fall.

Investors should tread carefully as any operational misstep or unforeseen change in preferences can have you catching a falling knife. Keeping that in mind, here are three restaurant stocks we’re swiping left on.

Papa John's (PZZA)

Market Cap: $1.36 billion

Founded by the eclectic John “Papa John” Schnatter, Papa John’s (NASDAQ: PZZA) is a globally recognized pizza delivery and carryout chain known for “better ingredients” and “better pizza”.

Why Are We Wary of PZZA?

1. Weak same-store sales trends over the past two years suggest there may be few opportunities in its core markets to open new restaurants
2. Estimated sales growth of 1.8% for the next 12 months implies demand will slow from its five-year trend
3. Capital intensity has ramped up over the last year as its free cash flow margin decreased by 3.8 percentage points

At $41.57 per share, Papa John's trades at 17.2x forward price-to-earnings. Check out our free in-depth research report to learn more about why PZZA doesn’t pass our bar.

Denny's (DENN)

Market Cap: $196.1 million

Open around the clock, Denny’s (NASDAQ: DENN) is a chain of diner restaurants serving breakfast and traditional American fare.

Why Should You Dump DENN?

1. Recent restaurant closures reflect a shift toward streamlining existing locations to maximize efficiency
2. Revenue base of $452.3 million puts it at a disadvantage compared to larger competitors exhibiting economies of scale
3. Free cash flow margin dropped by 13.2 percentage points over the last year, implying the company became more capital intensive as competition picked up

Denny’s stock price of $3.77 implies a valuation ratio of 6.6x forward price-to-earnings. To fully understand why you should be careful with DENN, check out our full research report (it’s free).

The ONE Group (STKS)

Market Cap: $94.05 million

Doubling as a hospitality services provider for hotels and resorts, The One Group Hospitality (NASDAQ: STKS) is an upscale restaurant company that operates STK Steakhouse and Kona Grill.

Why Does STKS Give Us Pause?

1. Poor same-store sales performance over the past two years indicates it’s having trouble bringing new diners into its restaurants
2. Issuance of new shares over the last five years caused its earnings per share to fall by 19.9% annually while its revenue grew
3. 8× net-debt-to-EBITDA ratio makes lenders less willing to extend additional capital, potentially necessitating dilutive equity offerings

The ONE Group is trading at $3.03 per share, or 0.9x forward EV-to-EBITDA. Dive into our free research report to see why there are better opportunities than STKS.

Stocks We Like More

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