Valuation metrics for the restaurant industry

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Price-to-earnings ratio

There are three valuation methods you can use to value a restaurant stock. The most widely used valuation approach under market approach is the price-to-earnings ratio. The idea is that companies with similar characteristics and fundamentals should trade at the same multiples. For example, Darden Restaurant (DRI) and DineEquity (DIN) are competitors. They’re trading at 22x and 24x, respectively. Chipotle Mexican Grill (CMG) is trading at 51x, and Panera Bread (PNRA) is trading at 24x, according to NASDAQ.

You can calculate this ratio by taking the price of the stock for a shareholder over the earnings per share, usually forward estimates for a better measure.

You should compare a company’s price-to-earnings ratio with the industry average price-to-earnings ratio to determine whether the company’s overvalued or undervalued.

Note that you can also gain access to restaurant stocks through the exchange-traded fund (or ETF) Consumer Discretionary Select Sector Standard and Poors depositary receipt (or SPDR) (XLY).

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The price-to-earnings-to-growth ratio

The price-to-earnings-to-growth ratio is also used to determine whether a company is overvalued or undervalued. This method is better suited for valuing a high-growth restaurant.

It’s calculated as the price-to-earnings ratio of a share over the annual growth rate of the earnings for that share. The lower the price-to-earnings-to-growth ratio the better, as the company may be undervalued. But companies with strong fundamentals are usually priced above 1.0x. A company with a higher growth rate and stronger business model will often outperform.

Dividend yield

You can calculate dividend yield by taking the annual dividend per share over the stock price of one share.

Mature companies with excess cash flows often distribute dividends back to their shareholders. These companies generally come with lower risk and are popular among income-seeking investors. Fast-growth companies, as you can see in the above chart, find it more profitable to reinvest in their businesses as opposed to paying out dividends, as they reinvest any of their excess earnings to fuel growth. We will discuss this in more detail in the next part of this series.

EV/EBITDAR

Restaurants aren’t all similar in structure. Some companies have leases, and others don’t. So we need a better measure to account for this difference.

Enterprise value/earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs (or EV/EBITDAR) accounts for leases and is a better measure than the price-to-earnings ratio to compare companies with different leases and ownership structures. EV is calculated as a company’s market capitalization plus its total debt less its cash and investments. EBITDAR is calculated as revenue less expenses excluding tax, interest, depreciation, amortization, and restructuring, or rent costs.

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