Nicholas Rossolillo

The Motley Fool

Americans love it when someone else does the cooking.

According to data compiled by the U.S. Census Bureau, spending on eating out increased 6% in 2018 and is up another 4% in 2019 so far, outpacing the 3% average increase in retail spending. In fact, as of this year, spending on eating out is about on par with, and soon to pass, money spent at grocery stores.

Given this situation, now must be a golden era of investing in restaurant stocks, right? Sort of. Growing though it is, the restaurant business is notoriously competitive, and technology is disrupting the status quo for many operations. Where there are winners, there are just as many losers.

Who's winning, who's losing

Industry researcher Technomic's Restaurant Business recently released its top 500 U.S. chains in 2018. Fast food, especially hamburgers, is winning. So is Chick-fil-A, which jumped to the fifth-largest chain in the U.S. (from number seven in 2017) with a 13.5% increase in sales. The only other change on the list was Panera Bread, which overtook Yum! Brands' Pizza Hut for the #10 spot.

Besides those shifts in the top 10 list, sales were up nearly across the board, with only oversized Subway notching a loss. However, it's clear that chains pairing take-out/delivery options with "healthier" fare and menu innovation are winning the biggest sales gains.

As mentioned earlier, hamburgers continue to be a big winner, too. Better-burger options like Shake Shack, The Habit, and their privately held peers like Five Guys and Culvers notched double-digit increases. America's love for the hamburger and the convenience that the food embodies continues to resonate. While not posting the same kind of double-digit expansion as the upstarts, the trend has meant more sales for McDonald's and Restaurant Brands' Burger King as well.

As for the biggest winners in the top 10 list – Starbucks, Chick-fil-A and Domino's – convenience has proved key to growing in the crowded restaurant space. A menu that guests love is, of course, important, but making ordering easy via an app and offering pickup or delivery for diners on the go are also among the things consumers want. For all the talk about how bad fast food is, the numbers prove that fast and convenient ranks high.

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More choices = less profit

With sales surging, why aren't all restaurant stocks a buy? Well, in order to capture the increasing number of dollars spent on eating out every year, there has been a huge uptick in new store openings.

In fact, the majority of chains posting growth are doing so in large part by expanding their store counts. Foot traffic at existing restaurants has been sparse at best as a result. According to restaurant researcher TDn2K, the average restaurant has actually been suffering from falling foot traffic for years because of over-expansion.

Comparable store sales, an average of number of purchases and purchase size per location, is important because it's the primary driver of profitability on a per-location basis. Average comps are (barely) positive because of menu price increases, but foot traffic declines are bad news for incumbents, which are losing sales to those chains still expanding aggressively. With profits slim and getting slimmer, many chains are in a precarious spot after losing customers for so long.

Domino's embodies this trend with its "fortressing" strategy, opening new stores even if they cannibalize a few sales from nearby Domino's locations. The idea is to locate pizza ovens as close to the consumer as possible, making Domino's delivery or pick-up the quick, convenient and top-of-mind choice. It does mean some locations will suffer from lost foot traffic, but the overall trend has remained positive so far. Comparable store sales were up 3% in the second quarter of 2019, and total sales grew 4%. Starbucks has employed a similar strategy, complementing its ample footprint with digital ordering and rewards tools to keep coffee drinkers coming back. Comps grew 7% at existing Starbucks stores in North America in the second quarter.

Convenience is king

Which restaurant stocks are the best bang for the buck? Menu innovators are important to look for, but it's convenience (via delivery options and apps) that's winning the battle. McDonald's, Starbucks, Domino's Pizza and Shake Shack all look like good picks for the long haul, as their respective strategies to pick up market share are yielding results.

A word of caution, though: Many restaurant stocks have surged in value over the last year, with stock returns far outpacing gains in bottom-line profits. This is an especially volatile industry, and many chains that have at the very least been able to maintain foot traffic numbers (like McDonald's and Starbucks) amid a scourge of new store openings have been rewarded with big stock returns. Valuations are stretched, and it could be high-time for a breather. That shouldn't be an issue for long-term investors who can buy the dips, but it's worth bearing in mind with worries of economic slowdown and signs of slowing comps in the restaurant industry cropping up.

Nevertheless, consumer reliance on eating out is on the rise, a trend that by all indications will continue as Americans seek out convenience to accommodate busy schedules. Chains that can deliver on that front, paired with compelling menu options that keep diners coming back, will continue to win in the long-term.

Nicholas Rossolillo owns shares of Domino's Pizza. The Motley Fool owns shares of and recommends Starbucks. The Motley Fool recommends Dunkin' Brands Group. The Motley Fool has a disclosure policy.

The Motley Fool is a USA TODAY content partner offering financial news, analysis and commentary designed to help people take control of their financial lives. Its content is produced independently of USA TODAY.

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