Restaurant Stocks: The Next Market Bubble?

by Will Ashworth | April 4, 2014 9:59 am

Restaurant Stocks: The Next Market Bubble?

There’s a lot of talk at the moment about both a biotech bubble and a tech bubble. In some ways, it’s like we’re back in 1999[1] when anything with a pulse was racing to the moon. (Of course, in hindsight, we all know what happened next.)

Bubble Restaurant Stocks: The Next Market Bubble?
Source: Flickr[2]

Stock bubbles always leave someone holding the bag — don’t let it be you.

Speaking of bubbles, there’s one that almost no one is talking about.

A select group of restaurant stocks — not all, mind you — have outperformed their peers as well as the S&P 500 by a country mile over the past year. This success is fueling the IPO fire with several growth stories that have recently gone public or are planning to do so in the near future.

All of this speculative action begs the question: Can these restaurant stocks keep it up in 2014 and beyond, or is a “pop” in the cards? That’s what I’m here to answer.

The Select Few

Restaurant stocks as a group are up 18% through March 31 while the S&P 500 gained 24% in the same period. Year-to-date, restaurant stocks are up a measly 0.4% compared to 2.7% for the index. So, as a group, its performance has been mediocre at best.

But a large number stand out from the rest — as in, at least doubling the index, so, 44% or greater in the past year:

Restaurant Stocks With Total Return of 44%-Plus in the Past 12 Months
Company TICKER Total Return Company TICKER Total Return
Sonic SONC 80% Red Robin Gourmet Burgers RRGB 64.4%
Chipotle CMG 76.7% Wendy’s WEN 63.9%
Jack in the Box JACK 72.9% Del Frisco’s Restaurant Group DFRG 61.3%
Buffalo Wild Wings BWLD 66.7% Domino’s Pizza DPZ 53.5%
Fiesta Restaurant Group FRGI 65.8%
Source: Morningstar

This is a very disparate group of restaurants. If you sat down a year ago to pick some winners in the restaurant space, you never would have been able to capture all nine of these businesses because there’s representation from quick service, fast casual, casual dining, fine dining and even pizza delivery and take-out.

You’ve got a little bit of everything.

Next Page[3]

Usually, when one picks winners, you tend to focus on a segment of the industry you think is going to do well. You might believe that fast casual will outperform, so you pick the best stock of the bunch  — in this case it’s Chipotle — and invest in that. I suppose you might go with a second segment such as quick service, but few individual investors would dare to venture much further into restaurant diversification.

Thus, your odds of success, even by investing in the PowerShares Dynamic Leisure and Entertainment Portfolio (PEJ[4]), which currently holds seven of the nine stocks[5] from above, is slim to none because it’s reconstituted four times a year. Most of these names will be gone by the end of the summer.

Valuation Bubble

According to Yahoo Finance, the restaurant industry’s average P/E at the moment is 23.1, whereas the nine companies from above have a multiple of 41.7 — 80% higher than the industry as a whole. At the very least, this difference in valuation suggests these particular stocks might be a little ahead of themselves.

Whether a bubble exists depends on a number of different factors. Let’s take a look at a few individual names to explain:

I Could Go On

Go through all nine of these stocks and really take a good look at each of their businesses — assessing their pros and cons — and I think you’ll find most if not all of them are performing exceptionally well from an operational standpoint. Investors have simply voted with their wallets as to which concepts are the winners over the past year in the restaurant industry.

Talk all you want about a bubble, but from where I sit I see a bunch of stocks that are dear in price because investors are afraid of the old saying, “Pay peanuts, get monkeys.” With U.S. stocks into the sixth year of a bull run, owning quality has become even more important.

There’s nothing to see here. Move along. Maybe buy something on your way out.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

Endnotes:
  1. it’s like we’re back in 1999: http://articles.economictimes.indiatimes.com/2014-04-01/news/48767262_1_mark-zuckerberg-biotech-ipos-social-media-company
  2. Flickr: http://www.flickr.com/photos/trodel
  3. Next Page: http://investorplace.com/2014/04/market-bubble-restaurant-stocks/2/
  4. PEJ: http://studio-5.financialcontent.com/investplace/quote?Symbol=PEJ
  5. seven of the nine stocks: https://www.invesco.com/portal/site/us/financial-professional/etfs/holdings/?javax.portlet.endCacheTok=com.vignette.cachetoken&javax.portlet.pst=72e337bf3b31ef1a015fe531524e2ca0_&javax.portlet.begCacheTok=com.vignette.cachetoken&javax.portlet.prp_72e337bf3b31ef1a015fe531524e2ca0_ticker=PEJ
  6. SONC: http://studio-5.financialcontent.com/investplace/quote?Symbol=SONC
  7. growth strategy: http://blogs.marketwatch.com/behindthestorefront/2014/03/25/sonic-sees-opportunity-to-eat-mcdonalds-lunch/
  8. MCD: http://studio-5.financialcontent.com/investplace/quote?Symbol=MCD
  9. FRGI: http://studio-5.financialcontent.com/investplace/quote?Symbol=FRGI
  10. CMG: http://studio-5.financialcontent.com/investplace/quote?Symbol=CMG
  11. March 31 article: http://www.fool.com/investing/general/2014/03/31/why-chipotle-is-severely-overvalued.aspx
  12. PNRA: http://studio-5.financialcontent.com/investplace/quote?Symbol=PNRA
  13. god-awful place: http://investorplace.com/2013/07/what-restaurant-is-the-new-fast-food-king/#.Uzri7ty52bw

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