Have you ever dreamed about owning a Chipotle Mexican Grill (NYSE:CMG) or Buffalo Wild Wings (NASDAQ:BWLD) restaurant? A good old fashioned Mc Donald´s (NYSE:MCD), perhaps? The idea is temting, but given the huge start-up costs and obvious risks, maybe investing in restaurants via the stock market is a better choice than opening your own franchise.
Franchisers vs. franchisees
Buying shares of a restaurant company in the stock market is not the same as owning your own individual restaurant: you don´t get to run the store or make management decisions, among many other potential disadvantages. On the other hand, shareholders benefit from diversification and liquidity, and minimum investment requirements are clearly much smaller.
Investing in Mc Donald´s means owning a little piece of the company´s gigantic store base with more than 34,500 restaurants, serving nearly 69 million customers in more than 100 countries each day. This means an amazing degree of international diversification, including exposure to high growth emerging markets where the company has plenty of room for expansion if it plays its cards well.
Importantly, Mc Donald´s operates nearly 80% of its stores via its franchises and affiliates system, and this provides healthy profitability and resilient cash flows through the ups and downs of the economic cycle. Being the franchisor as opposed to the franchisee can sometimes mean higher profits and lower risks for investors.
Chipotle doesn´t franchise, so buying the stock may be the only way to invest in the company and profit from its growth. This approach has negative implications for the company when it comes to free cash flow generation, but it also means that Chipotle gets more control over its stores and products.
Quality is a crucial variable for Chipotle, the company´s business model is based on serving a simple menu of quality food prepared with fresh ingredients and served in a quickly and cool atmosphere. Making sure that Chipotle maintains its differentiating attributes as the company becomes bigger over time is a central piece of its long term growth strategy.
As of the end of the third quarter Buffalo Wild Wings had 534 franchised restaurants and 415 company-owned stores for a total of 945 stores. The company is maintaining a balanced mix when it comes to store openings during 2014: management plans to open 45 company-owned and 40 franchised locations in the United States and Canada, and it expects international franchisees to open at least 10 restaurants across the globe during the year.
Investors looking for a balanced mix between the higher profitability and simplicity provided by franchises and the superior quality control produced by company-operated stores can find a good alternative in Buffalo Wild Wings.
Choosing from the menu
Investing in restaurants via the stock market allows investors to choose alternatives with different growth and valuation characteristics. In addition to that, you can position your portfolio in competing companies, which is a great strategy to reduce risks even if it also reduces your potential for gains as opposed to only picking the winning names.
Chipotle is a hot as it gets, the organic burrito company is firing on all cylinders with revenues rising by 18% and same store sales jumping 6.2% in the last quarter. For this kind of performance, investors need to pay a spicy valuation, the company trades at a P/E ratio around 54.4 times earnings.
Buffalo Wild Wings is heavily spiced too, the company reported an amazing growth rate of 27.9% in revenues during the last quarter fueled by a 4.8% increase in same-store sales at company-owned restaurants and 3.9% at franchised locations. The chicken wings powerhouse is also flying high with a P/E ratio in the area of 40.6.
Mc Donald´s, on the other hand, is offering a much cheaper valuation with a P/E ratio near 17.7. There is a good reason why the stock is cheap, though: system wide sales increased by only 1.2% in the first ten months of the year, and comparable store sales rose by a lackluster 0.3% during the same period.
It's no secret at all that fast casual companies like Chipotle have been gaining market share from Mc Donald´s over the last quarters as many customers prefer to pay a few extra bucks for higher quality food with better nutritional characteristics.
The house of Ronald Mc Donald is responding with product innovation to attract more customers to its stores, new options like its Mighty Wings are intended to steal some chicken wing fans away from Buffalo Wild Wings. Even if the company has not achieved much success judging by recent sales numbers, the fact remains that the restaurant business is fiercely competitive.
The stock market allows investors to analyze competitive dynamics in the industry and position themselves in several attractive companies at the same time as opposed to one big investment to open a single restaurant, and this is a big advantage in terms of diversification and risk management.
The stock market allows investors to invest in different restaurants with their own business strategies, growth prospects, valuation and competitive strengths. If you want to own a restaurant, maybe placing an order with your broker is a better idea than opening a franchise.
Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends Buffalo Wild Wings, Chipotle Mexican Grill, and McDonald's. The Motley Fool owns shares of Buffalo Wild Wings, Chipotle Mexican Grill, and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.