Small cap stocks are generally defined as stocks that have a market cap between $250 million to $1-$2 billion, although this range varies on your source. Nevertheless, small-cap stocks have two key advantages for the individual investor. First, there is a large opportunity to beat institutional investors like mutual funds. This is because mutual funds have restrictions that limit them from buying large portions of any one issuer’s outstanding shares. Also, the very nature of the goal of mutual funds – consistent, predictable, non-volatile returns – make small caps off limits for the most part. Second, small cap stocks have the growth potential that large cap stocks don’t have. The following companies are 3 small cap restaurants with great long-term potential.
Nathan’s Famous, Inc. (NASDAQ:NATH)
When it comes to hot dogs, no brand is more famous than Nathan’s Famous, Inc. (NASDAQ:NATH). The company is generally ignored in the flooded restaurant sector based on their low coverage and average daily volume, but the stock has slowly provided outstanding returns over the past decade. Its share price has gone up over 1300% the past 10 years and nearly 50% this year alone. With a P/E of nearly 33, the market has high expectations for Nathan’s Famous, Inc. (NASDAQ:NATH) in the coming years, and in my opinion it has earned that premium.
Nathan’s Famous, Inc. (NASDAQ:NATH) has just 308 units across 27 states and 8 countries, with retail distribution across all 50 states in over 32,000 supermarkets. Profit margins are in the top 20 for the restaurant industry and 75th percentile of all traded stocks in the US. Net income for 2012 FY was $6.16 million vs. $2.2 million in the 2011 fiscal year. 3rd quarter 2013 FY earnings shows that net income is up another 16.5% to $5.913 million, with revenue increasing 9.2% to $56.6 million. This is a huge positive because net income is rising faster than revenue, showing that business efficiency is improving.
Other positives for the company include its ability to overcome Hurricane Sandy last October, which forced the closing of all company-owned restaurants, including its famous Coney Island location. That location re-opened this past Memorial Day weekend, and this should help push its 4th quarter sales higher and make 2013 FY a new record for net income. The potential Chinese takeover of Smithfield Foods, Inc. (NYSE:SFD) by Shuanghui International could also be a plus for Nathan’s Famous, Inc. (NASDAQ:NATH). Nathan’s Famous, Inc. (NASDAQ:NATH) is currently in a business agreement with John Morrell & Co., which is a Smithfield Foods, Inc. (NYSE:SFD) subsidiary, that promises Nathan’s to be an exclusive licensee to manufacture and sell branded hot dog, sausage, and corned beef products at retail. The potential for Nathan’s to penetrate the Chinese market while also seeing 12% growth in their Branded Product Program may push Nathan’s to much higher share prices.
Red Robin Gourmet Burgers, Inc. (NASDAQ:RRGB), Inc.
If hot dogs aren’t your thing, perhaps burgers are. Red Robin Gourmet Burgers, Inc. (NASDAQ:RRGB), famous for their gourmet burgers and Zagat’s winner of Best Burger within the full-service restaurant category 4 years in a row, has only 475 total locations, and its stock has is up over 50% year-to-date. The hamburger industry is estimated to be growing at a 4% pace annually because it is affordable, portable, and customizable, and Red Robin Gourmet Burgers, Inc. (NASDAQ:RRGB), Inc. fits right in.
1st quarter 2013 FY earnings showed total revenues increased 2.3% to $306.3 million, while restaurant-level operating profit margins increasing 0.3%. The quarter was the 11th consecutive of same store sales growth with continued expansion of operating margins.
Red Robin Gourmet Burgers, Inc. (NASDAQ:RRGB), Inc. is now testing smaller-footprint prototypes in order to improve store expansion and perhaps evolve the company into the popular fast-casual category that Chipotle Mexican Grill, Inc. (NYSE:CMG) currently dominates. They are reducing their traditional 6,000 sq ft locations to 4,000, while introducing their Burger Works chain of restaurants that use smaller 2,000 sq ft footprints. This is a possible game changer as it moves into the territory of Five Guys, In-N-Out Burger, and Whataburger. This could help the chain acquire new customers from university campuses, smaller downtown locations, and shopping malls.
Del Frisco’s Restaurant Group, Inc (NASDAQ:DFRG)
If you combine luxury, first-class service, wine, and delicious steaks, you’d find yourself at a Del Frisco’s Restaurant Group, Inc (NASDAQ:DFRG). The July 2012 IPO’d company owns 35 restaurants across 19 states and each follows 1 of 3 contemporary, high-end, complementary concepts: Double Eagle Steak House, Sullivan’s, and The Grille. All 3 concepts are famous for their steaks accompanied by their award-winning wine selection.
1st quarter 2013 FY results show that revenue increased 13%, while overall net income declined due to new restaurant openings and expansion. However, The Grille saw revenue increase 90% due to 3 new openings. Monthly trading volume is starting to pick up as the stock has gained more media coverage in recent months.
Del Frisco’s Restaurant Group, Inc (NASDAQ:DFRG) offers a lot of potential to the patient investor. First, it’s relatively unknown across the restaurant industry and still under the radar. Instead of trying to cater to a wider income customer bracket, they are content with raising the bar with restaurant improvements and attracting higher income clientele. They are able to build the perception of being a premium brand and this allows them to charge very high prices. As a consequence, their New York location is the 2nd highest grossing restaurant in the entire country. Lastly, they have some immunity to the potential of higher food costs, and particularly beef prices. This is because only 33% of their sales come from beef.
NATH Total Return Price data by YCharts
The Power of Small
Neither of these restaurants carries a dividend. However, would it make sense for a restaurant in growth mode to be spending their extra cash on dividends instead of expansion? There is an investment philosophy behind buying retailers that are just getting started. If they have a concept that works in one place, there is a good chance that it can work all over the country. I don’t believe restaurants are any different. Both Nathan’s and Del Frisco’s Restaurant Group, Inc (NASDAQ:DFRG) have no debt, while Red Robin Gourmet Burgers, Inc. (NASDAQ:RRGB), Inc. is potentially onto a game changer as it moves in on fast-casual dining. In the end, people need to eat, and hot dogs, burgers, and steaks look like great portfolio options.
The article 3 Small Cap Restaurants With Great Potential originally appeared on Fool.com.
Michael Carter has no position in any stocks mentioned. The Motley Fool recommends Red Robin Gourmet Burgers. Michael is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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