When it comes to initial public offerings, it’s usually tech companies that get all the love. After all, tech tends to be where “the next big thing” springs from, so investors get excited, thinking they might be able to get onto the ground floor of the next Apple (NASDAQ:AAPL) or Google (NASDAQ:GOOG).
And while tech companies do have explosive potential, a few other sectors can score mega-returns, too. One in particular is the restaurant sector.
Why? Well, a key advantage is scale. If a restaurant has a proven concept — that is differentiated from the competition — the growth can be stunning. For example, wing-slinger Buffalo Wild Wings (NASDAQ:BWLD) has gained more than 500% since going public in late 2003. And of course there’s everyone’s favorite momentum stock, Chipotle Mexican Grill (NYSE:CMG), whose burritos exploded into 600% returns since 2006.
But, just like any company, and just like any public offering, investors need to be cautious. For every Chipotle, there’s at least one Planet Hollywood. And this week, investors were treated to a double helping of restaurant IPOs, with Outback parent Bloomin’ Brands (NASDAQ:BLMN) seeing some interest Wednesday, and Carl’s Jr./Hardee’s parent CKE Restaurants (NYSE:CK) set to go public Friday.
So what should you look for in a restaurant IPO? To get some help, let’s take a look at Chipotle’s IPO prospectus, which was filed in 2006. A few factors should catch your eye:
Rethink the Old Ways
When Chipotle got its start back in 1993, the founder Steve Ells wanted to go beyond the concept of a “fast-food” joint. So he created a restaurant that had high-quality raw ingredients, distinctive interior design and friendly customer service. Still, there would be some aspects of fast food — namely, low prices and speed. This approach eventually would become known industry-wide as “fast casual.”
Look for breakneck growth. In Chipotle’s case, its revenues nearly doubled from 2003 to 2005. Yes, the company grew a lot through expansion — by the time it came public, it already had 500 locations — but during this period, the company saw its average revenue per location go from $1.274 million to $1.5 million — a clear sign that customers loved Chipotle.
Also promising was Chipotle’s ability to produce strong cash flows. In that same 2003-05 period, EBITDA grew from $7.2 million to $59 million.
Restaurants often get too cluttered, especially when it comes to menus. This was far from the case at Chipotle. According to the prospectus:
“We do just a few things but try to do them really well, and we plan to keep this intentionally focused strategy as we grow.”
At the time of the IPO, the company only sold the following items: burritos, burrito bols (a burrito without the tortilla), tacos and salads. Very little has changed since then.
Eat the Food
If you can — in other words, if there’s any within a reasonable distance — check out a couple locations. Are there crowds at peak meal times? What are people saying about the food? Do you like the food?
OK, you might have been able to tell Chipotle was a good idea even if you didn’t like Mexican food, but it never hurts to have conviction about a place — plus the larger idea about doing as much homework as possible still holds true.
Had you done this with Chipotle, you would have verified the claims of the company’s prospectus — and been on your way to finding a breakout IPO.
Tom Taulli runs the InvestorPlace blog IPOPlaybook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli. As of this writing, he did not own a position in any of the aforementioned securities.