Shareholders of Dave & Buster's would probably like to forget the past six months even happened. The stock dropped 22.2% and now trades at $8.41. This was partly due to its softer quarterly results and might have investors contemplating their next move.
Is there a buying opportunity in Dave & Buster's, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
Why do we think Dave & Buster's will underperform?
Even with the cheaper entry price, we don’t have much confidence in Dave & Buster's. Here are three reasons you should be careful with PLAY, plus one stock we’d rather own.
1. Shrinking same-store sales indicate waning demand
Investors interested in consumer discretionary - leisure facilities companies should track same-store sales in addition to reported revenue. This metric measures the change in sales at brick-and-mortar locations that have existed for at least a year, giving visibility into Dave & Buster’s underlying demand characteristics.
Over the last two years, Dave & Buster’s same-store sales averaged 5.5% year-on-year declines. This performance was underwhelming and implies there may be increasing competition or market saturation. It also suggests Dave & Buster's might have to close some locations or change its strategy and pricing, which can disrupt operations. 
2. New investments fail to bear fruit as ROIC declines
ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
Unfortunately, Dave & Buster’s ROIC has decreased significantly over the last few years. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
3. Short cash runway exposes shareholders to potential dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Dave & Buster's burned through $16 million of cash over the last year, and its $3.05 billion of debt exceeds the $16 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the Dave & Buster’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of Dave & Buster's until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final judgment
Dave & Buster's falls short of our quality standards. After the recent drawdown, the stock trades at 8.7× forward EV-to-EBITDA (or $8.41 per share). This valuation is reasonable, but the company’s shaky fundamentals present too much downside risk. There are better investments elsewhere. We’d suggest looking at one of our all-time favorite software stocks.
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