In lieu of ejection by the Board of Director, Papa John’s CEO John Schnatter has chosen to step down from his management at the company that he founded by opening up a pizza business in a spare space in his father’s restaurant. From his own work ethic, he created a business that is worth over $2 billion.
As a wealth creator, I don’t think you could find 1,000 individuals in the past century that had a greater impact than he did. Schnatter’s secret to pizza wealth creation consisted of the following: (1) perpetual price hikes that were just a little bit higher than the rate of inflation, which he sustained perpetually until Domino’s decided to become the low-cost market participating and forced the other national chains to compete; (2) a fanatical focus on “order bundling”, or the recognition that a lot of money can be made when you can regularly induce customers to not only order pizza but soda and a side as well; and (3) a regular, systematic rollout of new store locations to augment the profit growth.
When your existing stores sell 3-5% more stuff each year, the price of that stuff also rises 4%, and you roll out an additional 3-8% in new locations, the components combine to give investors double-digit growth. Since its founding, Papa John’s has grown at about 18% per year. Since 2003, earnings per share have increased from $0.51 to approximately $2.75 today. By these accounts, Schnatter’s skills as an entrepreneur are highly praise-worthy.
Yet, as seems to be ever more prevalent these days, politics and recency bias have shown their fangs. The combination of Schnatter’s criticism of the NFL player protests, coupled with the stock’s decline in price over 30% in the past year, have precipitated his exit.
Schnatter is not receiving a fair, holistic evaluation from his critics.
Regarding the criticism for the stock price declining 30%, that is a function of stock market participants correcting for their excessive enthusiasm for the stock earlier in the year. When it was trading at $90 per share, and earning only $2.55 in profits, the valuation was 35x earnings. With non-cyclical companies, it is necessary to receive a string of 13% annual earnings increases to justify that.
Otherwise, there is a reversion towards the 20x earnings range. The P/E compression when a business transitions from 35x earnings to 20x earnings requires the stock price to fall 42%, absent other considerations. In Papa John’s case, the “other considerations” is earnings growth, and because Papa John’s continues to grow profits, the price of the stock only fell by 30% rather than a more expected 42%.
Expressing any kind of dissatisfaction with Schnatter for this stock price performance is like attending a basketball game where Kevin Durant puts up 35 points, and then consider him to be an underperforming athlete when he “only” puts up 20 points per game the rest of the season. The problem isn’t with Durant–it’s with the incorrect expectations you developed.
Schnatter deserves a better send off. Papa John’s stock has grown by double-digits in fourteen of the past seventeen years. Every dollar invested in the stock back in 2003 is worth $5.50 today. The S&P 500 wouldn’t have even turned your dollar into $2.75.
Between 2014 and 2016, Papa John’s stock rose wildly from $37 to $90. It shouldn’t only risen to $50 during the 2015 to 2016 time frame. It is curious how the sequence of return alters our perceptions. If Papa John’s had risen gradually from $37 in 2014 to $59 today, people would be satisfied with the 59% gain over the course of four years–that’s 12.3% annual compounding.
But, instead, Papa John’s rose from $37 to $90 and then fall to $59, and therefore, Schnatter is somehow to blame. He’s essentially being penalized for the irrationality of others. He didn’t overbid the stock. He didn’t tell you to pay 35x earnings. He kept the business growing at one of the highest sustained rates in the history of corporate America, but the stock price decline and the wrong side of politics has caused to discard his almost four decade stretch of operational excellence. Human nature, and groupthink, have taken an unwarranted bite into his legacy.
Originally posted 2017-12-21 23:13:59.