3 Reasons CHH is Risky and 1 Stock to Buy Instead

Over the past six months, Choice Hotels’s shares (currently trading at $117.17) have posted a disappointing 18.9% loss, well below the S&P 500’s 11.6% gain. This may have investors wondering how to approach the situation.

Is there a buying opportunity in Choice Hotels, or does it present a risk to your portfolio? Get the full breakdown from our expert analysts, it’s free.

Why Do We Think Choice Hotels Will Underperform?

Despite the more favorable entry price, we're sitting this one out for now. Here are three reasons why CHH doesn't excite us and a stock we'd rather own.

1. Declining RevPAR, Demand Takes a Hit

In addition to reported revenue, RevPAR (revenue per available room) is a useful data point for analyzing Travel and Vacation Providers companies. This metric accounts for daily rates and occupancy levels, painting a holistic picture of Choice Hotels’s demand characteristics.

Choice Hotels’s RevPAR came in at $53.78 in the latest quarter, and it averaged 1.7% year-on-year declines over the last two years. This performance was underwhelming and implies there may be increasing competition or market saturation. It also suggests Choice Hotels might have to invest in new amenities such as restaurants and bars to attract customers - this isn’t ideal because expansions can complicate operations and be quite expensive (i.e., renovations and increased overhead).

2. Revenue Projections Show Stormy Skies Ahead

Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite.

Over the next 12 months, sell-side analysts expect Choice Hotels’s revenue to drop by 1.5%, a decrease from its 10.7% annualized growth for the past five years. This projection doesn't excite us and implies its products and services will see some demand headwinds.

3. New Investments Fail to Bear Fruit as ROIC Declines

A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared to the money it has raised (debt and equity).

We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Unfortunately, Choice Hotels’s ROIC has decreased significantly over the last few years. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.

Final Judgment

We cheer for all companies serving everyday consumers, but in the case of Choice Hotels, we’ll be cheering from the sidelines. Following the recent decline, the stock trades at 16.5× forward P/E (or $117.17 per share). This valuation is reasonable, but the company’s shaky fundamentals present too much downside risk. There are better stocks to buy right now. We’d suggest looking at one of Charlie Munger’s all-time favorite businesses.

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