Restaurants increase convenience and give many people a place to unwind. But the side dish is that they’re quite difficult to operate because high inventory and labor costs generally lead to thin margins at the store level. This leaves little room for error if demand dries up, and it seems like the market has some reservations as the industry has tumbled by 11.8% over the past six months. This drop is a far cry from the S&P 500’s 6.4% ascent.

Investors should tread carefully as any operational misstep or unforeseen change in preferences can have you catching a falling knife. Taking that into account, here are three restaurant stocks that may face trouble.

Krispy Kreme (DNUT)

Market Cap: $599.2 million

Famous for its Original Glazed doughnuts and parent company of Insomnia Cookies, Krispy Kreme (NASDAQ: DNUT) is one of the most beloved and well-known fast-food chains in the world.

Why Do We Think DNUT Will Underperform?

1. Earnings per share have dipped by 38.7% annually over the past three years, which is concerning because stock prices follow EPS over the long term
2. Increased cash burn over the last year raises questions about the return timeline for its investments
3. Depletion of cash reserves could lead to a fundraising event that triggers shareholder dilution

Krispy Kreme is trading at $3.48 per share, or 4x forward EV-to-EBITDA. Check out our free in-depth research report to learn more about why DNUT doesn’t pass our bar.

Portillo's (PTLO)

Market Cap: $518.4 million

Begun as a Chicago hot dog stand in 1963, Portillo’s (NASDAQ: PTLO) is a casual restaurant chain that serves Chicago-style hot dogs and beef sandwiches as well as fries and shakes.

Why Is PTLO Not Exciting?

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. Lacking free cash flow generation means it has few chances to reinvest for growth, repurchase shares, or distribute capital
3. Short cash runway increases the probability of a capital raise that dilutes existing shareholders

At $7.27 per share, Portillo's trades at 18.1x forward P/E. To fully understand why you should be careful with PTLO, check out our full research report (it’s free).

Noodles (NDLS)

Market Cap: $31.77 million

Offering pasta, mac and cheese, pad thai, and more, Noodles & Company (NASDAQ: NDLS) is a casual restaurant chain that serves all manner of noodles from around the world.

Why Do We Steer Clear of NDLS?

1. Disappointing same-store sales over the past two years show customers aren’t responding well to its menu offerings and dining experience
2. Incremental sales over the last six years were much less profitable as its earnings per share fell by 47.8% annually while its revenue grew
3. High net-debt-to-EBITDA ratio of 6× could force the company to raise capital at unfavorable terms if market conditions deteriorate

Noodles’s stock price of $0.70 implies a valuation ratio of 2.2x forward EV-to-EBITDA. Check out our free in-depth research report to learn more about why NDLS doesn’t pass our bar.

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