|Written by GSCR Staff|
|Wednesday, 24 July 2013 07:17|
In yesterday’s Market Monitor we tied in baseball and McDonald’s (NYSE – MCD) in a modern Americana lexicon theme about emotions and guarding against investing and/or trading with them.
Right on cue, Wendy’s (NASDAQ – WEN - $7.23) announced positive earnings yesterday following McDonald’s which announced on Monday. The stock jumped nearly 14%, but the main driver was the company announcing it was restructuring to more franchise owned stores, thus potentially reducing operating and maintenance costs by significant amounts.
First off, I need to disclose that I would never buy or short WEN. Not for any issues with the company or stock, but I have too many personal connections or emotional ties to the company. I grew up and reside in Columbus, Ohio where the company is headquartered. My father worked at the corporate offices, and I actually met R. Dave Thomas while working as a maintenance grunt over one summer in college several years ago. Clearly, as I mentioned, investing or trading WEN would not be an objective endeavor for me, which is a bad thing. But I digress…
Burger King (NYSE – BKW) has restructuring plans as well to phase out corporate stores and go to more of a franchise-based model. This may be the case of follow the leader.
Analysts who follow the sector love metrics like same store sales, profit margin, and operating margin. Economic trends, like the rising costs of food for example, can change the outlook for the industry in a big way due to the effects on these margins and overall sales. These fast food chains must balance organic growth with new markets and new menu items with the associated costs and efficiency losses. When looking at these stocks it might be prudent to think ‘outside the box’ and do your own research with a new metric like the Number of Menu Items. Clearly McDonald’s turned things around about 10 years ago when the company decided to focus on quality and service versus growth. Wendy’s has emulated MCD in this fashion to a certain degree and made traction as well with an economic ‘value’ menu. See follow the leader up above.
So what does all this mean for you the retail investor? BKW, MCD, and WEN are out of our market cap space, although WEN is barely out. More importantly the sector is not a traditional small cap play in a greater esoteric sense. Unlike biotech or technology, there is a finite domestic market for stores, unless you think restaurants on the moon or Mars are coming soon. Additionally, as mentioned above, too many menu items or expanding services too broadly usually has a detrimental effect on earnings and thus the stock price over time. The message is that sometimes growth in the industry is hard to get and even harder to maintain.
MCD is a great long term blue chip stock that pays a nice dividend of $3.18 if you seek income and growth. WEN actually looks very bullish in the short term. But in general these stocks do not offer the same potential for growth as the traditional small cap sectors, and as a rule usually are not worth adding to the satellite portion of your portfolio. Earlier this year we broke this rule and highlighted Denny’s (NASDAQ – DENN), and the stock is up 12.4%. The gain is not trivial, but when you consider the S&P is up 15% and the Dow Jones is up 16% over the same period, we may have missed the boat allocating this capital to our satellite portfolio. It may have been better spent on some of our big winners in biotech or semiconductors, several of which are up 50% or higher.
A valuable lesson!
Have a great day.
Aaron Schweitzer, Vice-President
Disclosure: Goldman Small Cap Research analysts are neither long nor short these shares but may elect to purchase the stock within the next 48 hours.
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