When I began investing, I was starting from a knowledge base of zero.
One of the first books I read was The Motley Fool's Rule Breakers, Rule Makers. In it, Motley Fool co-founder Tom Gardner laid out specific criteria for crowning a company a Rule Maker: a mature, consumer-facing business that's king of its market space, and an investment that can confidently and profitably be held onto for years, with only quarterly check-ins.
His step-by-step process for analyzing a business was an easily understandable way for a beginner like me to quickly get up to speed; but its back-to-basics approach will benefit even advanced investors. Today, we're going to run Panera Bread (NASDAQ:PNRA.DL) through Tom's merciless gauntlet and see exactly what makes it a classic Rule Maker and, as such, possibly the ideal long-term stock.
1. The mass-market, repeat purchase of low-priced goods
Panera sells coffee, cookies, pastries, sandwiches, soups, and salads in a warm, cozy atmosphere, with a dining experience that straddles the line between fast food and classic sit-down-for-the-duration establishments.
While the food isn't exactly cheap, it's certainly not expensive; like the dining experience itself, the pricing ends up somewhere in the middle. But, however it works on a technical level, the Panera formula keeps people coming back for more and, as such, earns Panera high marks on our first Rule-Maker metric.
2. Gross margin
Gross margin indicates manufacturing efficiencies, brand power, and pricing power. The ideal gross margin for a Rule Maker is 60%.
- Panera only manages a 35% gross margin trailing twelve months.
- Chipotle Mexican Grill (NYSE:CMG) does mildly better, hitting 38% TTM.
- Einstein Noah (NASDAQ:BAGL) does significantly worse, managing only 24% TTM.
- Starbucks (NASDAQ:SBUX) does very well on this metric, with a gross margin TTM of 56%.
Margins are typically on the slim side in the restaurant business, but Starbucks shows that high gross margins can be achieved. Panera, at least, comes in right at the industry average for gross margin, but still needs to do better here.
3. Net-profit margin
Net-profit margin dictates how many pennies a company gets to keep from every dollar of sales. Tom Gardner likes to see net-profit margins of 10% for his Rule Makers.
- Panera's net-profit margin comes in a bit under our Rule-Maker ideal, at 7.81% TTM.
- Chipotle hits the metric right on the head here, at 10.43% TTM.
- Einstein Noah, at 3.64% TTM, obviously isn't setting the Rule-Maker world on fire right now.
- Starbucks is doing very well on this metric, with a net-profit margin of 10.41% TTM.
4. Sales growth
Year-over-year sales -- or revenue -- growth counts even for big companies, where it will naturally slow with age, because it's an indicator of business momentum. Top-tier Rule Makers grow their sales by 10% every year.
- Finally, Panera knocks one out of the park, with year-over-year quarterly sales growth of 16.8%.
- Chipotle does even better, with sales growth of 18.4% YOY.
- Einstein Noah decidedly doesn't knock this metric out of the park, with YOY revenue growth of just 1.9%.
- Starbucks, always caffeinated and ready to rock, showed Rule-Making revenue growth of 11% YOY.
5. Cash-to-debt ratio
Rule Makers should be cash heavy and debt light, ideally having at least 1.5 times more cash than debt:
- $290 million in cash, and zero debt, gives Panera the ideal cash-to-debt position.
- $574 million in cash, and $3.6 million in debt, gives Chipotle the fantastic C/D of 159.
- $12.6 million in cash, and $68.6 million in debt, gives Einstein Noah the not-so-fantastic C/D of 0.18.
- $2 billion in cash, and $550 million in debt, gives Starbucks the simply marvelous C/D of 3.63.
6. The Foolish Flow Ratio
The Foolish Flow Ratio measures how well a company manages its inventory and cash. A company should be keeping its inventory and accounts receivables low, and its accounts payables high: strong indicators of market-space dominance.
To calculate the Foolish Flow Ratio, take current assets minus cash, cash equivalents, and short-term investments, then divide by current liabilities. The acceptable upper limit for F/F is 1.25, but the lower the number, the better:
- Panera does great on this metric, with an F/F of 0.53.
- Chipotle, too, with an F/F of 0.52.
- Einstein Noah has its balance sheet in order here, as well, with an F/F of 0.72.
- Starbucks is no slacker on this metric either, with a very healthy F/F of 0.98.
7. Your familiarity and interest
What's in a name? Quite a bit. Your familiarity and interest with a company help you understand exactly what it does and how it makes money, thereby lowering your overall investing risk.
Panera isn't quite McDonald's, or even Chipotle, but the name is getting to be better and better known. And, as long as it's well known to you, and you have a penchant for stopping by often and checking out its victuals, that's what matters most on this final Rule-Maker benchmark.
Panera: classic Rule Maker, and ideal long-term stock
Panera could use a boost to both its gross margin and its net-profit margin but, otherwise, it's a strong performer and a classic Rule Maker. Remember that Rule Makers don't need to knock every metric out of the park; their strength lies in their ability to perform over the long run -- and that's Panera.
Always remember to check in on your Rule-Maker investments once a quarter by running them through this simple checklist. In Rule Breakers, Rule Makers, Tom Gardner goes into even greater depth and detail about what exactly makes a Rule Maker a Rule Maker. I suggest you pick up a copy for yourself, and get the whole story from the man who wrote the book on it.
Fool contributor John Grgurich owns shares of both Chipotle and Starbucks. Follow John's dispatches from the bleeding edge of capitalism on Twitter @TMFGrgurich. The Motley Fool owns shares of Microsoft. The Motley Fool owns shares of Chipotle Mexican Grill, Panera Bread, and Starbucks and has the following options: short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend Chipotle Mexican Grill, Panera Bread, and Starbucks. The Motley Fool has a strangely gripping disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.