Spot the Best Restaurant Stock: Chipotle, McDonald’s, Starbucks, Yum

Source: https://www.flickr.com/photos/mr_t_in_dc/

Source: https://www.flickr.com/photos/mr_t_in_dc/

It is difficult to succeed in the restaurant industry. There is a lot of competition, and input costs are often volatile. Therefore, a lot of investors choose to look for opportunities elsewhere. However, if you can find winners in the sector, you can make a lot of money. Everybody needs to eat, and people often develop regular eating patterns. Therefore, if you invest in the right restaurant stock, you’ll be investing in a company that has loyal, repeat customers and pricing power. This is a recipe for consistent profits on strong margins that are, in most cases, recession resistant.

In what follows, I suggest four ideas that investors should consider for their portfolios. All of these companies have proven to succeed in the areas I mention above, and they all have the potential to be winners in the long run.

1. Chipotle Mexican Grill (NYSE:CMG)

This is a favorite stock among investors. The company’s inexpensive Mexican restaurants are located throughout the country and they are extremely popular. As a result, the company has become one of the largest restaurant owners in the world; Chipotle currently has a market capitalization of $16 billion. Going forward, investors and management alike believe that the company will continue to be able to grow.

However, despite the fact that analysts are bullish and despite the fact that I think the company will be able to grow, there are a couple of issues. The first is rising food prices. The company’s first-quarter earnings took a hit because food input costs rose. If this continues, the company’s sales growth will remain weak. The company fought back by raising prices, but this can alienate customers and dissuade them from going back. The second is that the stock is extremely expensive — investors have extremely high expectations for the company, and so it trades at over 40 times earnings.

So while Chipotle may be a winner, it is also vulnerable to a correction, and I would stay away.

Source: Thinkstock

Source: Thinkstock

2. Starbucks (NASDAQ:SBUX)

Starbucks is the world’s leading operator of coffee shops. It operates thousands all over the world. It has incredible brand recognition, and as a result, it has been able to develop an army of loyal customers who buy from Starbucks daily. The company also has strong profit margins that exceed 10 percent. While rising coffee prices were a concern earlier in the year, investors should note that the price of coffee doesn’t impact the company’s costs — which are mostly labor and operating costs (e.g. rent, utilities, etc.) — significantly.

Like with Chipotle, the shares are fairly expensive, although they aren’t extraordinarily expensive at 26 times earnings. Given Starbuck’s repeatable revenue base, one can justify paying this price, especially since the company is growing its sales at more than 10 percent annually. Starbucks also deserves to trade with a premium multiple given that it is largely recession proof. Therefore, I think investors should consider taking a position in Starbucks, especially if it pulls back to below $70/share.

Source: Thinkstock

Source: Thinkstock

3. McDonald’s (NYSE:MCD)

McDonald’s is the largest operator of restaurants in the world. It isn’t going to make you rich, but the company has a long history of creating shareholder value, growing its business, and customer loyalty. Virtually everybody in the United States has at one time or another eaten McDonalds’ food, and the same can probably be said about several countries in Western Europe.

McDonald’s has been a relatively strong stock this year as investors hunt for safety and consistently. Still, the shares trade with a modest 17.6 multiple on 2014 earnings. This is a reasonable price to pay considering how low interest rates are. If you are looking for bond-like safety yet returns that are superior to bond yields, McDonalds is a stock to own.

Source: Thinkstock

Source: Thinkstock

4. Yum! Brands (NYSE:YUM)

Yum! Brands was a great way for American investors to play China and other emerging markets up until a couple of years ago. Then the company had a scare in China — consumers began to question the safety of the company’s food, and its leading restaurant chain — Kentucky Fried Chicken. Chinese sales tanked and this hit the company. However, now the company has fixed its image, and once again Chinese sales are soaring. This is one of the fastest growing restaurant businesses with growth exceeding 20 percent this year. It will be in the high teens in the future if everything goes right. The company trades with a P/E multiple in the mid-20s and so it is a little expensive. But the company’s growth potential is very real, and I think that the stock can be purchased on weakness.

Disclosure: Ben Kramer-Miller has no position in the stocks mentioned in this article.

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