Hungry for Good Investments

I was a big fan of ABC's Wide World of Sports growing up. I loved the catchphrase: "spanning the globe to bring you a constant variety of sports." When I became an adult and had less time for television, I became a big fan of the wide world of food, spanning the globe to find a constant variety of comestibles. This, coupled with my love of investments, pushed me to span the globe to find the best restaurant companies. There are too many fine contenders to actually mention, so I decided to focus on three I've had a lot of experience with.

P.F. Chang's China Bistro (NASDAQ:PFCB), Cheesecake Factory (NASDAQ:CAKE), and Outback Steakhouse (NYSE:OSI) have several things in common. They all serve very good food. Their menu items are all reasonably priced, with entrees costing what I call the mid-range of $10 to $20. There is almost always a long wait at each location. I am never disappointed after a visit to each establishment. They all have outstanding stock charts going back over five- or 10-year periods.

Oh, and one other thing. I don't own any of these stocks because I always thought they were too expensive. And the other reason is because I once invested in a little restaurant company known as Koo Koo Roo -- and despite the lines and good product, it went bust-o thanks to bonehead CEO Kenneth Berg.

That bad experience cost me -- not just because I lost 100% of my investment, but because I got turned off to restaurant stocks. And boy, did I miss out. These three restaurants were classic Peter Lynch investments in that they were sitting right in my own backyard, had products I was familiar with and liked, and were businesses most people thought of as too difficult to sustain. I mean, heck, the average margin for the industry is a measly 2% to 3%! If anything, I should have invested just based on the waiting times at these restaurants -- forty-five minutes to an hour. You know a restaurant is popular when they hand you those little localized pagers that signal you when it's chow time.

So I figured it was time to throw in the towel, lay these eateries side by side to see if they presented any value, and see how expensive they are on a relative basis (compared to their historical averages).

Here's a quick primer for those who have never eaten at these places. P.F. Chang's is to Chinese food what a cafe in Paris is to a U.S. coffeehouse. That is, the food is really a more upscale version of your hole-in-the-wall local Chinese take-out restaurant. Bistro really is a fitting description. The Cheesecake Factory serves not only multiple varieties of the signature cheesecake, but also a zillion types of appetizers, pizza, pasta, seafood, steaks, salads, and sandwiches. Outback Steakhouse serves what you'd expect, along with other meat and chicken dishes, but owns seven other chains consisting of 300 restaurants serving everything from Italian food to seafood to just wine.

Alrighty, let's have a look-see at the financial info for our trio:

What do I see here? First, all of these places have respectable profit margins. In fact, I am particularly impressed by Cheesecake Factory's margins considering the heaping portions it serves. Everyone is comparable on a return-on-equity basis as well, and everyone is in pretty good shape on the balance sheet. I don't like to see more cash than debt generally, but because Outback is expanding, I don't mind that so much -- and the debt numbers are not out of control. I am also impressed again by Cheesecake, because it's financing its expansion using cash from operations, without using debt. That is something to love. It also shows a prudent and modest expansion plan. Outback raced into the world with 800-plus stores, while Cheesecake is taking its time. I like that kind of deliberation in management.

That said, borrowing might well reduce the overall cost of capital (the cost of debt is generally lower than the cost of equity) and increase the overall return on each "project" (i.e., a restaurant opening or refurbishment) and the firm itself. So it might be wise for the company to enlist the assistance of debt, because that would stand to reduce its overall cost of capital.

Some investors choose not to make a big deal out of low insider holdings, saying insiders are entitled to diversificaiton, but it's always a red flag for me. Why wouldn't an insider want to own a big share in his own business, unless he thinks that business is overpriced, or worse, that something is wrong with it?

Next, we see that all three are growing earnings at very impressive rates, but are also priced accordingly ... and beyond. Now, as I said earlier, I was a chump for not buying any of these companies years earlier because they seemed too expensive. But even allowing these companies to carry a certain premium, Outback Steakhouse is the only one that looks reasonably priced to me. Its P/E (based on earnings estimates for the current fiscal year) is in line with its growth rate, resulting in a price-to-earnings-to-growth ratio of 1. Also, the P/E based on current and next-fiscal year estimates is near the bottom of the historical P/E range. In fact, if you look at its chart on a P/E basis, Outback has not even had a P/E this low in several years. A company like this deserves a premium, in my opinion -- so there may just be some value in Outback. I also like that Outback is diversified over several different types of cuisines in its empire of 1,100-plus stores.

Now, while my timing on Cheesecake Factory and P.F. Chang's isn't so great, I will keep an eye on them. One never knows when Mr. Market will spaz out and whack stocks like these for no apparent reason. If they're given enough of a hit, I'd be inclined to buy them on pullbacks.

In the meantime, I'm going to keep an open mind about restaurant chains. But buyer beware. In a business with margins this low, there had better be more than just a line out the door to earn your investing dollars.

If you want to learn more about these chains, chow down on these articles:

• W.D. "40" Crotty chats about Cheesecake.
• Alyce Lomax also thinks P.F. Chang's is too pricey.
• Matt Thurmond reminds us of the importance of same-store sales.

Fool contributor Lawrence Meyers eats at all of the chains mentioned here, but does not own stock in any of them. Before you buy or sell any stock, do your own research. The Motley Fool is investors writing for investors.