Over the past six months, Papa John’s shares (currently trading at $34.24) have posted a disappointing 15.5% loss, well below the S&P 500’s 8.4% gain. This was partly driven by its softer quarterly results and might have investors contemplating their next move.

Is now the time to buy Papa John's, or should you be careful about including it in your portfolio? Get the full breakdown from our expert analysts, it’s free.

Why Do We Think Papa John's Will Underperform?

Even though the stock has become cheaper, we're sitting this one out for now. Here are three reasons you should be careful with PZZA and a stock we'd rather own.

1. Shrinking Same-Store Sales Indicate Waning Demand

Same-store sales is an industry measure of whether revenue is growing at existing restaurants, and it is driven by customer visits (often called traffic) and the average spending per customer (ticket).

Papa John’s demand has been shrinking over the last two years as its same-store sales have averaged 1.5% annual declines.

2. Low Gross Margin Reveals Weak Structural Profitability

Gross profit margins are an important measure of a restaurant’s pricing power and differentiation, whether it be the dining experience or quality and taste of food.

Papa John's has bad unit economics for a restaurant company, signaling it operates in a competitive market and has little room for error if demand unexpectedly falls. As you can see below, it averaged a 12.1% gross margin over the last two years. That means Papa John's paid its suppliers a lot of money ($87.94 for every $100 in revenue) to run its business.

3. Shrinking Operating Margin

Operating margin is a key profitability metric because it accounts for all expenses keeping the business in motion, including food costs, wages, rent, advertising, and other administrative costs.

Analyzing the trend in its profitability, Papa John’s operating margin decreased by 3.6 percentage points over the last year. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Papa John’s performance was poor no matter how you look at it - it shows that costs were rising and it couldn’t pass them onto its customers. Its operating margin for the trailing 12 months was 4.5%.

Final Judgment

We cheer for all companies serving everyday consumers, but in the case of Papa John's, we’ll be cheering from the sidelines. After the recent drawdown, the stock trades at 19.9× forward P/E (or $34.24 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. There are more exciting stocks to buy at the moment. We’d suggest looking at a dominant Aerospace business that has perfected its M&A strategy.

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