Using Forbes' Restaurant Rankings To Evaluate The Underlying Stocks

by: Jefferson Starship

Two weeks ago, Forbes released a list of America’s most popular chain restaurants based on survey by Market Force Information. The restaurants were ranked by consumer ratings on “quality of food, taste of food, speed of service, friendly service, cleanliness, overall value, atmosphere, child-friendliness, healthy choices, and green/sustainable practices.” Now even though this list has little to do with the financial success of these companies, it is still useful for investors to know how the public perceives a company’s quality of service in order to determine its chance of future success.

The restaurant industry has certainly not been immune to the economic downturn. It seems that the number of consumers who have traded down from high-priced restaurants to more affordable chain restaurants has been exceeded by the number of people who have traded down from chain restaurants to fast-food or home-cooking. In short, the number of people going through the doors has decreased and some have had to offer discounts to drive sales, thereby decreasing profit margins. But this has left some stocks trading at huge discounts and several of them pay relatively strong dividends. Being able to lock-in some of these yields on companies that you are certain will be around for years can prove to be extremely prudent.

The Forbes list features the top 15 chain restaurants. Some will be left off the list below because they are not publicly traded: (5) Carrabba’s Italian Grill, (7) Outback Steakhouse (these are both owned by OSI Restaurant Partners, who also owns Bonefish Grill), (11) Golden Corral, and (14) TGI Fridays.

1) The Cheesecake Factory (NASDAQ:CAKE) – The Cheesecake Factory was number one on the list for two years in a row and Forbes cited their large portion sizes and atmosphere as contributing factors. There are less than 200 Cheesecake Factories so there is plenty of room for growth in that regard, but in this economic climate I’d imagine that franchisers are not lining up to open new restaurants. The stock has the second highest price-to-earnings (P/E) at 18 and does not pay a dividend, so it should be considered more of a growth pick. At 20% off their 52-week high they are trading at a discount and could offer some short term gains.

2) Texas Roadhouse (NASDAQ:TXRH) – According to Forbes, Texas Roadhouse’s negatives were overall value and cleanliness. However, they have extremely large servings and they allow eaters to throw peanut shells on the floor, so this may have attributed to their cleanliness score. If you are unfamiliar this company more can be found here. The stock’s P/E is slightly higher than the industry average, near 17, but it does pay a dividend currently yielding 2.3% and at a payout ratio of only 20%. Time will tell if Texas Roadhouse intends to increase their distributions annually.

3) Darden Restaurants (NYSE:DRI) – Darden is the best stock on this list for a number of reasons. The first is that their restaurants actually occupy three of the spots: Olive Garden at #3, Red Lobster at #6, and Longhorn Steakhouse at #10. Second, they have over 1,800 locations, making them significantly larger than the other companies and providing them with some brand equity. Lastly, they increased their dividend over the summer by 34% and are now yielding 3.7% while paying out only 41%. This is a relatively safe play with both growth and income prospects.

4) P.F. Chang’s China Bistro (NASDAQ:PFCB) – I have never been much of a fan for P.F. Chang’s as a restaurant or a stock. Their Forbes ranking is pretty surprising considering “it ranked lowest in the overall value, cleanliness, friendly service, speed of the service and taste of food” and second to lowest in quality of food. This should make you question the rankings because this makes the restaurant appear terribly unappealing. Anyway, they have under 400 locations, are 49% off their 52-week high of $53, and somehow are yielding 3.5%. This puts the current payout ratio at 49%, but P.F. Chang’s dividends are all over the map and differ each quarter. Given the pullback in price there may be a pullback in distributions to follow.

8) Cracker Barrel Old Country Store (NASDAQ:CBRL) – Forbes touted Cracker Barrel for its cleanliness, kid-friendliness, atmosphere, and healthy choices. They have around 600 locations, and are trading 28% off their highs of $57. This has brought their P/E down to only 11.5 (very low relative to the others) and the dividend yield up to 2.4%. The distribution was recently raised, as it has a history of doing outside of a 2-year freeze during the recession, and goes ex-div on Wednesday. Cracker Barrel covers these dividends with relative ease, paying out only 24%.

9) Red Robin Gourmet Burgers (NASDAQ:RRGB) – This restaurant came in last in atmosphere and health choices, and did not score well in quality of food, speed of service, or cleanliness. The stock has a high P/E at 27, does not pay a dividend, and is 41% off their 52-week high. So there is not really much to like about Red Robin, and they are very similar to a number of other restaurants with better branding and much better commercials. However, if you were bargain shopping and think they have a shot at righting the ship then the stock may be worth a second look.

12) DineEquity (NYSE:DIN) – DineEquity is better known as Applebee’s and IHOP and with over 3,200 locations they are far too big for their own good. They are the only company on the list that is losing money each year, and this forced them to pull their dividend in 2008. The stock is only 28% off its 52-week high of $60. Forbes claims that they score well in green practices, but this doesn’t really contribute to profitability. What’s more startling is how poorly this stock performed during the recession, falling from the $70 range to under $6. Management clearly has some serious work to do.

13) Brinker International (NYSE:EAT) – Aka Chili’s, which has a strong international presence, decent prices, and is kid-friendly. They have over 1,500 locations worldwide and its stock price is nowhere near as downtrodden as the rest of the stocks on this list. It scored low on the Forbes list because of cleanliness and quality of food, but as an investment it should be near the top. The company recently increased their dividend, which is now yielding 2.9% and paying out 37%. As a long term play this could make for a strong asset in an income portfolio, especially if you can pick them up when the yield is over 3% (this would occur at a price of $21.33).

15) Ruby Tuesday’s (NYSE:RT) – Like Applebee’s and Red Robin, Ruby Tuesday’s is just a little too generic to be competitive. They have just under 800 locations but they are not very profitable. The stock, at $7.71 is down 50% from its 52-week high. Like DineEquity, this stock took the recession very hard, falling from $30 to $1. And they are still struggling to maintain positive quarters. Their November earnings could be a driving factor for the stock going forward.

I hope this has provided some guidance for those that wish to add some restaurants to their portfolio. People need to eat, and in better economic times they will be eating out much more than they are right now. Also, the downturn has forced some of these companies to reevaluate how they do business which could better their margins going forward. As a final note, I found it interesting that the list did not include Buffalo Wild Wings (NASDAQ:BWLD). I like their business model and feel that they still have some room to grow as the nation’s largest chain sports bar.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.