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Restaurants have been some of the unsung investing heroes of the last decade. The National Restaurant News index, a measurement of more than 50 restaurant stocks, has risen 130% over the last 10 years, while the S&P 500 is up just 4%. In a world where there are now 7 billion mouths to feed, and the U.S. population continues its march upward, it's hard to see why that would change.
Let's look at four more reasons why this sector is a smart investment:
1. The industry is solid
We'll always need food, and though restaurants may be a luxury to some, it's one of the first places our discretionary income goes. Demand is generally steady, and trends affecting restaurants tend to be industry-specific as they are rarely influenced by disruptions such as new technology, geopolitical events, outsourcing, or innovation. Instead, the biggest impacts come from commodity costs and consumer spending habits. McDonald's (NYSE: MCD ) , easily one of the most valuable restaurant companies in the world, has been one of the consistently best-performing stocks since its IPO in 1965. A split-adjusted share purchased in 1970 would now be worth almost 300 times what it was then, and that's not including income from dividends.
Even better, a Morningstar index measuring the restaurant industry has outperformed the S&P 500 over the last 15 years by 11.38% to 5.23%, annualized, and the disparity only grows in more recent time horizons.
Of course, there can be risks out there such as fad diets or commodity costs, but restaurants generally fluctuate less than the market as a whole. In fact, the average beta for the 10 largest American restaurant stocks is 0.81, meaning it's a relatively safe place to let your money ride out the current waves of volatility.
2. You can visit your investment
Peter Lynch, one of the Fool's favorite investors, once said, "Visiting stores and testing products is one of the critical elements of the analyst's job." Take him up on his suggestion.
I once had an enlightening experience at a Chipotle (NYSE: CMG ) . When the burrito maker put some rice on my burrito, I told him I didn't want any. Instead of just scraping the rice off and passing it down the line, he threw the tortilla in the garbage and started with a fresh one.
This taught me two valuable lessons about the company that you would never get from perusing its financial reports. First, it takes its employee training seriously and does it well, and second, it knows the lifetime value of a customer far exceeds the price of a tortilla. Next time you're in a restaurant you're looking to invest in, take a moment to notice what makes its operations unique. These insights can prove invaluable.
3. It's immune to e-commerce
The biggest trend in retail these days is the shift online. Bookstores and video stores are becoming obsolete, and I'd venture a guess that office supply, sporting goods, and toy stores are next. Going forward, there will probably be fewer and fewer storefronts that sell "stuff," especially stuff that doesn't need to be physically experienced, the way clothing or furniture do, or purchased urgently like drugstore goods. It's a leap, but my guess is that more retail space will be occupied by service businesses, restaurants being a common example.
In my opinion, as competition for that prime commercial real estate decreases, rents could grow at a slower pace or even decline, and those choice locations will be easier to find. Look for restaurant companies that stand to benefit from this transition, which I think most favors younger companies like Panera (Nasdaq: PNRA ) , Buffalo Wild Wings (Nasdaq: BWLD ) , and Chipotle. These companies have the most growth ahead of them, and with more short-term leases, they'll be in a position to renegotiate better contracts.
4. International exposure
If you've picked up a paper or turned on the TV in the last 10 years, you know the real growth in the world is coming from China and other parts of the developing world. American brands like Yum! (NYSE: YUM ) , Starbucks (NYSE: SBUX ) , and McDonald's have proven their popularity abroad, and the burgeoning middle class in these countries is likely to drive restaurant sales far higher in the coming years.
Food consumption in India is expected to grow from $155 billion in 2005 to $344 billion in 2025, and Starbucks, looking to exploit their booming coffee market, appears to be on the verge of establishing a joint venture to enter the Indian market. Meanwhile, in China, the coffee siren recently announced plans to more than triple its number of locations there, and it has become a favorite among young Chinese white-collar workers.
Yum! Brands, parent of KFC, Pizza Hut, and Taco Bell, has already asserted its dominance of the Chinese market, now generating nearly 60% of operating profits from stores there. The popularity of American brands like these has only risen in the wake of food-safety scandals involving products such as tainted milk, as the Chinese have come to trust American brands, which they view as higher quality.
Foolish bottom line
A portfolio of just the three biggest restaurant companies -- McDonald's, Starbucks, and Yum! -- would have slaughtered the market over the last 10 years. Starting in January 2002, if you only held equal parts of these three companies, you would have realized gains close to 300% (again, without dividends), while the S&P has returned almost nothing.
Who will be the restaurant rock stars of the next decade? Looking ahead, I like Chipotle and Panera for their growing brand strength and market opportunities, and McDonald's, which has led the industry for two generations and shows no signs of letting up.
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