Of Restaurant Stocks and Value Meals

• ByDavid MacDougall, TSC Ratings Analyst
• On 5:00 am EDT, Tuesday October 27, 2009

BOSTON (TheStreet) -- Half of all restaurants fail in their first three years, according to some reports. Half shutter their doors in the first year, according to others. Regardless of which survey is correct, the fact is that creating a successful restaurant is extremely difficult. From determining the right menu choices to staffing to design and advertising, nothing is simple.

Still, companies such as McDonald's, Burger King, YUM Brands, Brinker and Darden are perennially successful. It's rare to see a vacated McDonald's, Olive Garden or Burger King. But just because restaurant chains are prolific doesn't mean they make for good investments.

Much of the restaurant industry is plagued by razor-thin profit margins and monstrous marketing costs. Brinker, owner of chains such as Chili's, On the Border and Macaroni Grill, and Darden, which operates Red Lobster, Olive Garden and, oddly, the upscale Capital Grille, have margins of 2.9% and 5.4%, respectively. The results are better among fast-food chains, with Burger King posting a profit margin of 7.9% and YUM Brands, which owns KFC, Taco Bell and Pizza Hut, coming in at 9.7%. McDonald's trumps them all, however, with a margin of 18.8%.

Interestingly, the performance of those companies' stocks is exactly the opposite of margin strength. Brinker and Darden have returned about 68% over the past year, with annual yield equivalents of nearly 20% for the past 10 years. YUM has performed admirably, with a gain of 31%. McDonald's and Burger King are badly lagging behind, with advances of only 10.6% and 2%, respectively. McDonald's also trails the S&P 500 Index in terms of annualized performance over the past 10 years.

It would have seemed that McDonald's and Burger King were no-brainer investments in the economic disaster that was 2009. With returns of minus 4.5% and minus 23%, respectively, those stocks tanked as others took off. McDonald's revenue has decreased about 7% this year, while Darden's sales have grown 2%. Customers trading down haven't been as much of a booster for McDonald's as initially expected. With so many sit-down options that are surprisingly cheap, the tradeoff to Ronald McDonald Land may not be worth it to some.

As the nation grows increasingly health-conscious, some Americans may not be able to cope with a Big Mac even though most entrees in sit-down alternatives like Chili's and Olive Garden are caloric nightmares that would give most wax-paper-wrapped fare a run for its money.

Compared with your local burrito joint, publicly traded restaurant businesses are more of a sure thing, yet that doesn't make all restaurants safe bets. Regardless of how many times the conventional wisdom is spouted that McDonald's is a good safety play, take a pause before entering the food industry through the golden arches.

Brinker and Darden are interesting alternatives, but temper your expectations. When it comes to food, Americans are fickle, and factors that no one can foresee can affect restaurant stocks.

-- Reported by David MacDougall in Boston.

Buzz up!