Over the last six months, First Watch’s shares have sunk to $17.63, producing a disappointing 8.7% loss - a stark contrast to the S&P 500’s 3.1% gain. 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 First Watch, 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.

Why Is First Watch Not Exciting?

Despite the more favorable entry price, we're swiping left on First Watch for now. Here are three reasons why you should be careful with FWRG and a stock we'd rather own.

1. Cash Burn Ignites Concerns

If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.

Over the last two years, First Watch’s capital-intensive business model and large investments in new physical locations have drained its resources, putting it in a pinch and limiting its ability to return capital to investors. Its free cash flow margin averaged negative 1.6%, meaning it lit $1.64 of cash on fire for every $100 in revenue.

2. Previous Growth Initiatives Haven’t Impressed

Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? Enter ROIC, a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).

First Watch historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 2.2%, lower than the typical cost of capital (how much it costs to raise money) for restaurant companies.

3. Short Cash Runway Exposes Shareholders to Potential Dilution

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.

First Watch burned through $25.09 million of cash over the last year, and its $837.5 million of debt exceeds the $18.61 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.

Unless the First Watch’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.

We remain cautious of First Watch until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.

Final Judgment

First Watch’s business quality ultimately falls short of our standards. Following the recent decline, the stock trades at 45× forward P/E (or $17.63 per share). Investors with a higher risk tolerance might like the company, but we think the potential downside is too great. We're pretty confident there are more exciting stocks to buy at the moment. We’d recommend looking at the Amazon and PayPal of Latin America.

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