Until recently, Buffalo Wild Wings Inc. (NASDAQ:BWLD) was an unstoppable growth story. The stock had run up more than 70%. It was up about 15% just this year, but that changed when it reported second-quarter earnings.
Curiously, there wasn't anything in its earnings report that seemed to justify its double-digit drop that wiped out this year's gains. The company put up growth that looked great on the surface.
But once again, unrealistic expectations were to blame. As Buffalo Wild Wings' stock soared over the past year, so did the underlying expectations that were embedded in its valuation.
Buffalo Wild Wings slightly missed the fairly high expectations embedded in its valuation. But it's growing strongly, and is performing much better than many of its restaurant peers.
Now that future expectations have come back into reasonable territory, the stock should perform better going forward.
Buffalo Wild Wings is performing better than most
The truth is, Buffalo Wild Wings had a great quarter, but you wouldn't know it judging by its stock price reaction after reporting. Same-restaurant sales and earnings per share grew 7% and 42%, respectively, versus the same quarter last year.
With numbers like that, you'd hardly think the company deserved a 15% haircut. But this is actually a recurring theme among restaurant stocks that were expected to produce higher numbers this earnings season. For example, Bloomin' Brands (NASDAQ:BLMN) shares sank 22% after reporting earnings that badly missed estimates.
The difference between the two is that Bloomin' Brands actually deserved its sell-off. Comparable-restaurant revenue barely inched higher last quarter, due to flat traffic. Bloomin' Brands is grappling with higher costs, and over the first six months of the year, earnings per share are down 41%.
Moreover, Bloomin' Brands doesn't expect its situation to improve any time soon. Along with its earnings release, management significantly cut its forecast for the remainder of the year. The company reduced its full-year EPS projection by 17% from its previous forecast, due to poor performance at several concepts including Carrabba's Italian Grill.
The lesson for all investors
Growth stocks like Buffalo Wild Wings get a lot of favorable attention from analysts and the financial media. Indeed, when things are good, high-growth companies offer outsized rewards. But it's foolish to think growth stocks' run will last forever. Too many investors think that a stock that has done well is a low-risk proposition.
But investing in high-flying growth stocks can often be a double-edged sword. That's because as sales and earnings grow and stock prices rally, expectations do the same. Analysts keep ratcheting up their earnings estimates, but that can't last forever. After all, mathematical and economic realities mean a company can only grow so fast.
When a company inevitably hits a stumbling block in its growth, bad things happen. For stocks that hold lofty valuations, this can result in extreme volatility, especially when a quarterly earnings report misses expectations.
That's exactly what happened to Buffalo Wild Wings.
When great isn't good enough
Remember that Buffalo Wild Wings operates in an industry jam-packed with competition. And, it's not like the economy is growing at extremely high rates. Cash-strapped consumers are still holding on to their purse strings tightly, particularly when it comes to eating out.
These are the reasons Bloomin' Brands hasn't performed up to par so far this year. On the other hand, Buffalo Wild Wings deserves credit for how well it's navigating the tough environment.
On the surface, there wasn't anything alarming about Buffalo Wild Wings' report. Far from it; in fact, the company produced huge growth rates. Its outstanding results prove the company is still growing strongly. To that end, Buffalo Wild Wings expects as much as 30% earnings growth this year.
The value of margins of safety
Buffalo Wild Wings stock traded for 37 times trailing twelve-month earnings per share and 27 times forward EPS estimates. With that type of valuation, it was very likely that the company wouldn't manage to meet such high expectations.
Now that the stock price has come down, so have future expectations. This leaves the window open for the company to do better going forward, since it has a much lower bar to clear in upcoming quarters.
It's easy to be disappointed over Buffalo Wild Wings slightly falling short of estimates last quarter. That being said, its performance should be appreciated considering how other restaurants, like Bloomin' Brands, are doing right now.
Buffalo Wild Wings is a hugely successful company that has a strong growth trajectory and generates solid profits. But a restaurant company in a saturated market can only grow so fast. When 42% earnings growth isn't good enough, it's clear that expectations got too high.
With lowered expectations going forward, it will be much easier for Buffalo Wild Wings to beat earnings estimates next time around.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.