In an economy that could spoil anyone's appetite, the fast-food arena serves up stellar performers alongside riskier picks. Investors should peruse the market's menu carefully before taking a bite of this sector.
Tasty fast-food stocks
Last week, McDonald's
So far, McDonald's price increases haven't deterred its loyal customers, or broken its amazing track record of outperformance. McDonald's has raised its prices twice in the last year as it navigates the difficult tightrope between passing rising costs along to consumers and providing compelling reasons to continue frequenting the Golden Arches. So far, its adjustments seem to be working. It may try to institute some more price increases, but management appears to recognize the dangers of pushing strapped consumers too far.
McDonald's trades at 16 times forward earnings, while Yum! Brands sports a forward price-to-earnings ratio of 17. Chipotle surely chokes value investing types with its forward P/E ratio of 39. Are these too pricey? Before you answer, consider some of the industry's less stable players.
Beware fast-food poisoning
Beleaguered consumers and rising commodity costs now plague all quick-serve companies. Some investors may think that bargains await in the niche's beleaguered second tier -- but these prospective buyers should beware.
Wendy's hasn't been able to turn a profit in the last 12 months, and its sales have fallen 3.6% in that time frame. Even if the company's making major strategic adjustments, it might be too late to regain its lost market share. Wendy's will report its latest earnings on Aug. 11.
Shares of fellow burger-slinger Sonic
Apply a liberal grain of salt to Sonic's recent quarterly results, which emphasized an expectations-beating profit, once it stripped out certain one-time items. One of these one-time costs related to debt repayments and refinancing. When you factor such adjustments back in, Sonic reported a third-quarter loss of $4.7 million, or an $0.08 loss per share. The company staggers beneath a total debt-to-capital ratio of 93.5%.
Such stocks must be cheap though, right? Not exactly. Wendy's trades at 22 times forward earnings. Sonic's forward price-to-earnings ratio is 16. Something smells rotten here.
Go for the gold
Perhaps investors assume that stocks like Wendy's and Sonic are better "deals" because they're most known for their recent struggles, and therefore supposedly ripe for a turnaround. (You could call this the "hope premium.")
Realistically, though, these companies charge investors too high a price for futures full of serious, possibly insurmountable challenges. McDonald's or Yum! actually trade more cheaply than, or at least at similar multiples to, Wendy's and Sonic. In another bonus, McDonald's and Yum! actually perform well on many measures, and have far less risky futures.
Pursuing the leaders in a given sector can be an extremely defensive strategy, especially in today's difficult macroeconomic environment. I believe McDonald's is a stronger contender than Yum!, but they're both doing well. Chipotle may be a pricier stock overall, but it's still got abundant growth potential. And any one of these companies is a lot better than Wendy's or Sonic.