Krispy Kreme Shares Plunge -- but Don't Panic

Krispy Kreme Doughnuts shares are getting fried this morning, down 6.3% as of 1:35 p.m. EDT -- though they're still up more than 100% over the past year -- in response to a downgrade to "neutral" from investment banker Wedbush.

According to Wedbush, you see, Krispy Kreme's incredibly sweet stock-price gains are entirely justified by the "acceleration in domestic company unit development, led by improved cash-on-cash returns and leading international unit growth." The problem is, the doubling in cost of Krispy Kreme shares now fully prices in these positive developments, leaving little room for the shares to run.

But Wedbush is wrong.

Oh, I understand how the analyst might think Krispy Kreme shares are fully valued today. For one thing, there's a powerful psychological trigger in noting that the stock has "doubled" in price over the past year. However, what's important at Krispy Kreme isn't what the stock has done in the past, but what the business will do in the future.

Analysts following Krispy Kreme see the company growing profit at 25% annually over the next five years. That's 650 basis points faster than what they forecast for Starbucks' profit growth and nearly 10 full percentage points faster than forecasts for Dunkin' Brands .

Granted, on the surface, Krispy Kreme carries a higher P/E ratio than either of these stocks, selling for 45 times trailing earnings versus 31 times earnings at Starbucks and 40 times at Dunkin'. But Krispy Kreme's real profitability is stronger than its GAAP financials suggest.

Free cash flow at Krispy Kreme topped $45 million last year -- more than twice its reported GAAP income of $21 million. Therefore when valuing the stock based on free cash flow, it's more accurate to say that Krispy Kreme sells for just 20 times cash profit -- rather than 45 times GAAP "earnings."

Paying 20 times FCF for a company that's growing at a 25% clip means that Krispy Kreme Doughnuts remains a bargain stock -- even at twice the price the shares cost a year ago.

The article Krispy Kreme Shares Plunge -- but Don't Panic originally appeared on Fool.com.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Starbucks. The Motley Fool owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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