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Better Buy: Shake Shack Inc. vs. Yum! Brands

By Rick Munarriz – Mar 23, 2016 at 2:27PM

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The fast-growing burger chain finds its stock a lot pricier than the parent company of Taco Bell, KFC, and Pizza Hut, but there's a reason for that.

Image source: Shake Shack.

The battle for supremacy in the realm of quick-service restaurants often boils down to quality vs. quantity. If you want sheer volume of sustenance, Yum! Brands' (YUM -1.15%) Taco Bell is the poster child. A few bucks can go a long way there. Yum! Brands' KFC and Pizza Hut also offer a good bang for the buck. Shake Shack (SHAK 1.74%), on the other hand, toils away in the "better burger" category where folks come in expecting to pay a bit more for burgers made of patties that are 100% all-natural Angus beef with no hormones or antibiotics.

It's not just the menu that's pricier at Shake Shack when pitted against Yum! Brands. Shake Shack trades at a lofty 87 times this year's projected profit and a still heady 69 times next year's target. Yum! Brands, on the other hand, fetches more reasonable multiples of 22 and 19 forecasts for 2016 and 2017, respectively. Yum! Brands also yields a modest 2.3% dividend. It will probably be several years before Shake Shack initiates a distribution policy.

This would seem to suggest that Yum! Brands is the smarter purchase at this point, but there's more to a stock's upside than payouts and P/E ratios. We need to assess where each company is in its growth cycle, for starters, and that's where Shake Shack has an obvious advantage.

Yum! Brands and its franchisees opened 2,365 new eateries last year, and systemwide sales grew at a mere 5% clip. Shake Shack opened just 21 units in 2015, and its revenue soared 64% for the year. There are still outlets for growth for Yum! Brands. It's opening its first Taco Bell in China, for example. However, Shake Shack has several years of double-digit percentage growth at the unit level.

This is why Shake Shack -- with most of its domestic locations run as company-owned operations -- should grow its sales and earnings at a much faster clip than Yum! Brands through at least the next few years. Growth matters. Analysts see revenue at Yum! Brands climbing just 3% this year. The midpoint of Shake Shack's guidance pegs its top line clocking in with a 26% gain.

A new item -- like the Chick'n Shack sandwich that was introduced earlier this year -- can move the needle. It remains to be seen if Taco Bell's Quesalupa, Pizza Hut's stuffed garlic knots-crusted pizza, or KFC's Nashville Hot Chicken can do the same.

The upside comes at a price, naturally. Shake Shack trades at fat premium to both the market and Yum! Brands across all valuation measuring sticks. It also carries the risk that comes with running a single hot concept, even though the diversification at Yum! Brands couldn't spare its financial results from sputtering when it was rocked in China. Revenue has actually declined at Yum! Brands in two of the past three years. However, both companies are home to great brands, and comps continue to outperform the restaurant industry at both Yum! Brands and Shake Shack. If you're willing to stomach the risk in the pursuit of greater returns Shake Shack may be the right stock for you, but you also will probably fare well in Yum! Brands if it's able to hold up well and offload the risk of its Chinese operations as it plans to do later this year. It's a battle of quantity versus quality, but both options can be appetizing for hungry investors.

Rick Munarriz owns shares of Shake Shack. The Motley Fool has no position in any of the stocks mentioned. 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.

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