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3 Restaurant Stocks That Have a Killer Advantage

By Demitri Kalogeropoulos – Feb 28, 2020 at 8:32AM

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McDonald's is one of several restaurant chains built for long-term success.

The restaurant industry is famously competitive, characterized by tiny profit margins and low barriers to entry. Even many established chains find it hard to stay relevant as consumer tastes shift from year to year.

Those facts can make it hard to separate compelling investments from the rest, but there are a few restaurant stocks that appear to have enduring competitive advantages. Below, we'll look at the factors that make McDonald's (MCD -0.80%), Starbucks (SBUX -0.63%), and Domino's (DPZ 3.08%) such attractive businesses.

McDonald's is big

McDonald's recently celebrated a major milestone with its Big Mac burger. Any company that can successfully market a sandwich for 50 years is probably doing something right.

Four friends sitting around a table and eating in a fast-food restaurant

Image source: Getty Images.

But while its menu is a major draw, Mickey D's real advantage is its scale. The fast-food titan serves roughly 70 million people across 100 countries each day. That traffic translated into $100 billion in food sales in 2019 alone.

It's hard to overstate the flexibility that this scale provides for the business. Combined with its industry-leading profitability, that cash allowed McDonald's to make its biggest real estate investment yet by remodeling its entire U.S. store base in just three years. The project began to show real progress by late 2019. The company also had enough resources remaining to deliver $25 billion to shareholders through dividends and stock buybacks over that period.

Starbucks has loyal customers

Most companies brag about their customer loyalty, but Starbucks takes that advantage to a higher level. That brand affinity shows up across the key growth metrics. Customer traffic jumped 3% in the core U.S. market last year, for example, while most other major chains struggled with flat or declining transaction counts. It's clear from the willingness of coffee fans to try its new beverages and offerings. The Starbucks loyalty program grew 16% in the most recent quarter to nearly 19 million active users.

The company has gone through periods of weakness in this area, including as recently as 2017. But the fact that it recovered to set new market-share highs is a strong indication that Starbucks can endure most competitive attacks against its dominant position.

Domino's is efficient

Domino's has been one of the market's best-returning stocks over the last 15 years. That fact has puzzled many industry watchers, given that it sells a simple product that is also produced by many other national chains, not to mention thousands of neighborhood restaurants.

But Domino's secret sauce is its efficiency. The delivery giant's small stores crank out impressive volume per square foot of selling space with market-leading profitability. Free cash flow in 2019 was $411 million -- up 50% year over year.

That efficiency has proven valuable, as a flood of new competition entered the home delivery space in 2019. While these new rivals knocked Domino's growth pace down a notch, that slowdown was mainly driven by unsustainably low prices. When these chains and third-party aggregators shake out of the industry, as investors saw in the most recent quarter, Domino's is well positioned to build on its leadership position.

Of course, their past successes don't guarantee future positive returns for these stocks. But there are good reasons why Domino's, McDonald's, and Starbucks continue growing their market share with each passing decade.

Demitrios Kalogeropoulos owns shares of McDonald's and Starbucks. The Motley Fool owns shares of and recommends Starbucks. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Starbucks Corporation Stock Quote
Starbucks Corporation
SBUX
$84.17 (-0.63%) $0.53
McDonald's Corporation Stock Quote
McDonald's Corporation
MCD
$245.95 (-0.80%) $-1.99
Domino's Pizza, Inc. Stock Quote
Domino's Pizza, Inc.
DPZ
$330.00 (3.08%) $9.86

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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