Restaurant Stocks: Putting Your Money Where Your Mouth Is
Book: Beating the Street by Peter Lynch with John Rothchild | ISBN: 978-0-671-75915-5
If you invested $10,000 in five restaurant stocks in the 1960s, splitting the money evenly between Kentucky Fried Chicken, Dunkin’ Donuts, Howard Johnson, Bob Evans Farms, and McDonald’s, you would have become a millionaire at least two times over by the end of the 1980s. Put it all in McDonald’s and you’d be a millionaire four times over.
Wall Street scoffed at hamburger joints and donut shops. They were busy chasing the Nifty Fifty tech stocks of the era. But Shoney’s became a 168-bagger. Bob Evans Farms became an 83-bagger. McDonald’s became a 400-bagger.
And the whole time, millions of customers were eating the evidence.
The Consumer Has the Edge
This is Lynch’s core argument with restaurant stocks. You don’t need an MBA or a Bloomberg terminal to evaluate a restaurant chain. You just need to eat there. Watch how many people are in line. Notice whether the place is clean. Check if the food is good. See whether you’d come back.
Every region of the country has produced winners. Luby’s and Chili’s in the Southwest. McDonald’s in the Midwest. Dunkin’ Donuts in New England. Shoney’s and Cracker Barrel in the Deep South. Sizzler and Taco Bell out West. These started as local favorites. Any observant customer could have spotted them early.
The Growth Machine
Restaurant chains have a built-in growth model that Lynch loves. A successful concept in one city can be rolled out across the entire country over 15-20 years. And here’s what makes it even better: they’re protected from competition in a way that tech companies aren’t.
If there’s a great fish-and-chips chain in California and a better one opens in New York, what’s the impact on the California chain? Zero. It takes years for restaurant companies to expand coast to coast. And nobody has to worry about cheap imports. Denny’s will never be undercut by a Korean restaurant chain shipping meals overseas.
Chili’s vs. Fuddrucker’s: A Cautionary Tale
Both started in Texas. Both served gourmet burgers. Both had distinctive restaurants. But Chili’s became a massive success and Fuddrucker’s lost a fortune.
The key difference? Speed of expansion. Fuddrucker’s tried to open more than 100 new locations per year and fell apart. Bad sites, bad managers, undertrained staff. Chili’s added 30-35 per year, stayed disciplined, and grew steadily under Norman Brinker, one of the best operators in the business.
Lynch saw this pattern over and over. Color Tile, Flakey Jake’s, TGI Friday’s. All moved too fast and paid the price. The restaurants that win are the ones that expand at a sensible pace. “Slow but steady may not win the Indianapolis 500, but it wins this kind of race.”
How to Evaluate a Restaurant Stock
Lynch breaks it down into a few things that matter most.
Same-store sales. This is the single most important number. Are existing locations selling more food than last year? If same-store sales are increasing, the concept is working. If they’re flat or declining while the company keeps opening new locations, you’ve got a problem.
Growth rate. You want a company that’s expanding, but not recklessly. Above 100 new outlets per year and you’re in the danger zone. Lynch prefers the slow-and-steady approach. 30-50 new stores per year is plenty.
Debt. Low to nonexistent is ideal. Restaurants that borrow heavily to expand fast are the ones that blow up.
Menu and margins. Some chains make money on high turnover with cheap meals (McDonald’s, Cracker Barrel). Others do low turnover with higher prices (Outback Steakhouse). Some have gift shops for extra revenue (Cracker Barrel). Some have high margins because their ingredients are cheap (Spaghetti Warehouse). All of these models can work. You just need to understand which one you’re looking at.
The 1990s Winners
By the early 1990s, the hamburger joints were getting saturated. The top five burger chains had 24,000 U.S. locations. The momentum was shifting to niche restaurants and medium-priced family spots. Montgomery Securities had a recommended restaurant list, and if you’d bought those eight stocks at the start of 1991, you would have doubled your money by December. The list included Cracker Barrel, Brinker International (Chili’s parent), Spaghetti Warehouse, Applebee’s, and Outback Steakhouse.
Au Bon Pain: Lynch’s Latest Find
Where did Lynch spot his next restaurant winner? The Burlington Mall, of course. Au Bon Pain started in Boston in 1977, went public in 1991 at $10 per share. It sold croissants and coffee, combining what Lynch called “French sensibility with U.S. efficiency.”
The stock doubled, then fell back to $14. At that price, it was a 25 percent grower selling for 20 times earnings. Lynch’s rule: any time you find a 25 percent grower at 20 times earnings, it’s a buy. “If I had a choice between investing in the state-of-the-art computer chip and the state-of-the-art bagel, I’ll take the bagel any time.”
The Takeaway
Restaurant stocks are the ultimate example of the amateur investor’s advantage. You eat at these places. You see which ones have lines out the door. You know which ones have stale food and dirty bathrooms. You experience the product in a way that no analyst reading a spreadsheet ever will.
As long as Americans continue to eat 50 percent of their meals outside the home, new 20-baggers will keep showing up in food courts and strip malls. The only question is whether you’re paying attention when you eat.
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