The Finance Professor
A Checklist for Profiting From Retail, Restaurant Stocks
Scott Rothbort
11/14/07 - 10:55 AM EST
Mid-November. One of the most active periods of the year for the retail and restaurant industries has begun. Last week, a slew of retailers issued their same-store sales data for October and many restaurant companies reported their third-quarter 
earnings . This week, many retail companies report their third-quarter earnings. Then next week, the really big retail hype begins as we converge upon Thanksgiving.
As Macy's (M - Cramer's Take - Stockpickr) Thanksgiving Day parade makes its way through Manhattan, the market braces for the annual retail milestones known as "Black Friday" and "Cyber Monday." From there, Hanukkah and Christmas are just around the corner. Restaurants also find this to be a stimulating time of the year as company parties, personal entertaining and retail shopping-related dining tends to increase restaurant sales.
Retail and restaurant stocks have very similar characteristics. Thus, developing a skill set for investing in one will greatly benefit investors when researching the other. This installment of The Finance Professor kicks-off a two-part look at retail and restaurant stock investing. Part one: 10 things to look and listen for, when researching retail and restaurant stocks.
1. Same-Store Sales
This is the most ballyhooed of retail and restaurant metrics. Same-store sales represent a comparison of sales at stores for an individual month vs. that same exact month in the prior year. For example, sales for one store in the month of September 2007 will be compared against the sales for that same store for the month of September 2006. A company will then aggregate all its same-store sales to derive same-store sales for the entire organization. This is important because it provides investors with a gauge of how a company is growing with its existing store base.
There are important prerequisites when making this calculation. The stores included in the count must be opened for at least 13 months. This insures that there is no break in service which could provide some bias to the comparison. Furthermore, stores which have moved during the last year may also be excluded. Thus, even though a store in "Anywhere, U.S.A." may have been open for business from September 2006 to September 2007, the fact that the store changed its location to another building, only a block away, might prevent inclusion in same-store sales.
Where investors can find this data: Same-stores sales are typically disseminated by a company in a press release, which is readily available on the company's Web site (usually in the "Investor Relations" section) or via an Internet-based business news sources. Additionally, for the more active investor, there are third-party subscription services that provide and analyze same-store sales data.
or acquisitions or takeovers. In other words, organic growth equals total sales growth minus growth from mergers, acquisitions and takeovers.
Organic growth is important because it will give us a clear indication how well the company can grow and expand its sales, by relying solely on its business model and existing resources.
Where investors can find this data: Organic growth is sometimes provided by a company's management team on earnings calls. However, the information is best ascertained by reading analysts research reports.
in one or more currencies other than U.S. Dollars (USD). McDonald's (MCD - Cramer's Take - Stockpickr), a restaurant, and Wal-Mart (WMT - Cramer's Take - Stockpickr), a retailer, are great examples of multinational companies that generate sales in many foreign currencies. Generating revenue in foreign currencies creates a complication in reporting sales data to investors because the foreign revenue streams have to be converted into USD.
Say, for example, total sales in Japan were JPY 100,000,000 in September 2006 when the JPY/USD "cross rate" was 120. Converted to USD, the sales were $833,333 (100,000,000 divided by 120) at that time. In September 2007, let's pretend that sales in Japan remained the same at JPY 100,000,000 but the JPY/USD cross rate is now 100. This would equate to sales of $1,000,000 (100,000,000 divided by 100). It would appear that sales rose 20%, when actually, sales in Japan remained unchanged. To rectify the discrepancy caused by foreign exchange fluctuations, a company will use last year's exchange rates when reporting same store and total sales changes. This is called "constant currency reporting."
Where investors can find this data: Constant sales data can de found via the same sources used for same-store sales and total sales.
5. Traffic
Traffic represents the number of transactions, tickets or checks that are processed by the retailer or restaurant. Put simply, the more people shop at a retailer or restaurant, the more likely total sales will increase. Just keep in mind that "traffic" refers to the actual store transactions, not foot traffic or number of window shoppers.
Where investors can find this data: Traffic data is not usually published, but it is sometimes available in company press releases and on quarterly conference calls.
6. Average Sales
Average transaction, ticket or check size is the average amount spent by each customer or table of customers at a retail or restaurant establishment. The average check increase or decrease expresses the total change in per transaction sales. As people spend more money for each purchase, the average sales amount will increase.
Average sales can be influenced by several factors:
- Change in general spending habits.
- Price changes in the menu (in the case of restaurants) or the unit (in the case of retailers).
- Change in product mix. (Product mix is the combination of different products with varying price points. For example, in a restaurant, average sales can increase if more people buy steaks rather than salads.)
are the purest forms of margins because they looks solely upon the relationship of sales to "cost of goods sold." Gross margins are expressed as a percentage and are calculated according to this formula: gross profits (net sales less cost of goods sold) divided by net sales (total revenues less returns, allowances and discounts).
The greater the gross profit margin, the greater percentage of sales will flow down through to the company's bottom line.
Where investors can find this data: Sometimes this information is provided in company press releases or discussed on the conference call. However, the best way to determine profit margins is by calculating it from the quarterly income statement.
8. Revenue vs. Sales
Up until now I have used the terms revenue and sales interchangeably. However, there is a very subtle difference that needs to be highlighted. Many companies, especially restaurants, will generate income in two different manners: direct sales, which are generated from company-owned stores, and franchise revenues, which are fees or revenue-sharing arrangements for units that are operated by a franchisee. The difference is important because the cost structures and hence, margins for both of these income streams are quite different.
For example, with company-owned restaurants, McDonald's will have to pay for the burgers and fries it sells to customers. Meanwhile at franchised locations, McDonald's franchisees will bear the cost of the sales, which McDonald's will share in the sales.
Where investors can find this data: Some companies will break out their income into more than one category in their financial statements (specifically, in the income statement) or in "notes" to the financial statements.
. Early on, I looked at the company's store location map and immediately saw the potential for expansion coast to coast.
Location takes on three dimensions: geographic diversity, physical location and real estate set-up.
First, what is the geographic diversity or concentration of a company's stores? For example, is the company concentrated in the Northeast United States or it spread out across the entire country? Also, in today's global free-trade marketplace we need to consider the mix of business within the U.S. and internationally.
Second, retail/restaurant investors should concern themselves with the physical structure of the locations. Are the stores self-standing or do they tend to be part of larger shopping strips or self-enclosed malls? Self-standing stores require shoppers to make a separate trip to the store, while mall-based stores get larger traffic flow from shoppers who will make a mall-based shopping expedition.
Finally, be cognizant if the company owns or leases its real estate . This will identify potentially undervalued assets (as with Sears Holdings (SHLD - Cramer's Take - Stockpickr)) or will identify potential risks for increased lease costs or loss of leases.
Where investors can find this data: This information is not easy to come by, but is most readily available from a company's annual reports and SEC filings.