From fast food to fine dining, restaurants play a vital societal role. 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 5.9% over the past six months. This drop is a stark contrast from the S&P 500’s 11.1% gain.

Some companies can grow regardless of the economic backdrop, but the odds aren’t great for the ones we’re analyzing today. Taking that into account, here are three restaurant stocks we’re passing on.

Market Cap: $8.2 billion

Starting from a single Washington, D.C. location, CAVA (NYSE:CAVA) operates a fast-casual restaurant chain offering customizable Mediterranean-inspired dishes.

Why Does CAVA Give Us Pause?

Operating margin of 4.6% falls short of the industry average, and the smaller profit dollars make it harder to react to unexpected market developments

Earnings per share have contracted by 15.6% annually over the last two years, a headwind for returns as stock prices often echo long-term EPS performance

Push for growth has led to negative returns on capital, signaling value destruction

At $70.52 per share, CAVA trades at 128.1x forward P/E. To fully understand why you should be careful with CAVA, check out our full research report (it’s free).

Market Cap: $321.4 million

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

Why Are We Out on DENN?

Disappointing same-store sales over the past two years show customers aren’t responding well to its menu offerings and dining experience

Subscale operations are evident in its revenue base of $457.2 million, meaning it has fewer distribution channels than its larger rivals

High net-debt-to-EBITDA ratio of 5× increases the risk of forced asset sales or dilutive financing if operational performance weakens

Denny's is trading at $6.23 per share, or 15.3x forward P/E. Check out our free in-depth research report to learn more about why DENN doesn’t pass our bar.

Market Cap: $73.65 million

Known for its bottomless steak fries, Red Robin (NASDAQ:RRGB) is a chain of casual restaurants specializing in burgers and general American fare.

Why Do We Think RRGB Will Underperform?

Weak same-store sales trends over the past two years suggest there may be few opportunities in its core markets to open new restaurants

Earnings per share have dipped by 19% annually over the past six years, which is concerning because stock prices follow EPS over the long term

Red Robin’s stock price of $4.10 implies a valuation ratio of 9.1x forward EV-to-EBITDA. If you’re considering RRGB for your portfolio, see our FREE research report to learn more.

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