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Franchise investing has been a popular investment among professional portfolio managers, as they have delivered superior returns. McDonald's (NYSE:MCD), Starbucks (NASDAQ:SBUX), Dunkin Brands (NASDAQ:DNKN), Group, and Panera Bread (NASDAQ:PNRA), for instance, have beat the S&P 500 by a big margin; and there are two good reasons for it.


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(Click to enlarge)

First, franchise companies usually ride on demographic trends that create favorable demand conditions.

McDonald's rode the favorable demographics of the 1960s for fast and inexpensive food, offering lunch and dinner in addition to breakfast, with coffee becoming a major item in the last decade, either sold inside conventional stores or as part of Cafes. It also offered convenience, with thousands of stores located in prime locations around the world.

Starbucks rode the baby boomer trend in the 1990s and the Internet revolution that fueled the need for public places to fill in the gap of missing social interaction. It offered baby-boomers and ailing telecommuters comfort, a "third place," an "affordable luxury" where they could share and enjoy a cup of coffee with friends and colleagues, away from work and home.

Second, franchise companies enjoy a number of sustainable competitive advantages, ranging from branding, economies of scale, and economies of networking.

But which franchise company offers the best prospect for investors?

It depends on the metrics used. McDonald's has the lowest PE, and the second highest operating profit margin among all four. However, the company's revenues and earnings growth rates have been heading south. This means that it is a good investment proposition for value investor, but not for growth investors.

The same could be true, but less so, for Starbucks.

Dunkin Brands and Panera Bread, by contrast, trade at a higher PE, but it enjoys enjoy higher revenue and growth rates. This means that Panera is a good investment for growth investors, while Dunkin Brands is somewhere in between, according to these metrics.

Company

Forward PE

Operating Margins

Qtrly Revenue Growth (yoy)

Qtrly Earnings Growth (yoy)

Return On Assets (ROA)

Starbucks

20.92

13.54%

11%

0.10%

14.45%

McDonalds

15.96

30.29

-0.20

-3.50

15.71

Dunkin' Brands Group

23.67

37

5

298

4.92

Panera Bread

23.26

7.81

16.80

26.60

15.22

These conclusions are further supported by another metric, SWOT Analysis.

McDonald's SWOT Analysis

Strengths

Weaknesses

Opportunities

Threats

Well-recognized band name; high operating margins;

menu expansion and upgrade; store refurbishing; little sensitivity to economic conditions

A high calorie/high cholesterol diet menu image.

Little room to grow, both geographically, and in terms of menu

Competition from Burger King; Wendy's (NASDAQ:WEN); Five guys; Dunkin Brands; Panera Bread; Yum Brands; Chipotle, and local upstarts (e.g., Goody's in the Balkan area, and Moss Berger in Japan).

Starbucks SWOT Analysis

Strengths

Weaknesses

Opportunities

Threats

Well- recognized brand name; still run by the company founder.

Lack of dinner menu;

Product portfolio sensitive to economic conditions; High degree of market saturation

Expansion to the tea market with the acquisition of Teavana; continuing expansion to China.

Competition from McDonald's McCafe; Dunkin Brands; and Panera Bread

Market saturation

Dunkin Brands Group SWOT Analysis

Strengths

Weaknesses

Opportunities

Threats

Well-recognized brand name

Core products enjoy high profit margins

Lack of dinner menu, which can explain the low ROA;

Plenty of room to grow-last week, the company announced plans to expand to expand to California

Competition from McDonald's McCafe; Starbucks; and Panera Bread

Panera Group SWOT Analysis

Strengths

Weaknesses

Opportunities

Threats

Still managed by the company founder; broad menu that covers breakfast lunch and dinner; new-more spacious stores

Management risks of losing market focus, as it tries to cater to every age group.

Plenty of room to grow-the company is still in the early stages of its expansion-just opened a store in Manhattan

Competition from; McDonald's; Dunkin Brands; Panera Bread; and Yum Brands

The bottom line: All four companies make good investment bets. McDonald's and Starbucks are more suitable investments for value portfolios, especially when their dividend payout is taken into consideration. Dunkin' Brands Group and Panera Bread are more suitable for value portfolios.

Source: Which Franchise Is A Better Investment For Your Money?