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TheStreet Open House

Restaurants Continue to Deliver

Stocks in this article: RTFGRIBJRI

NEW YORK ( TheStreet) --The restaurant freight train continues to roll. Historically, restaurant stocks have been one of the top performing sectors coming out of recessions, primarily due to two factors.

First, during recessions the supply of restaurants either contracts or does not grow, as weaker chains are forced to close, and the healthier ones slow their growth. Once consumers regain their confidence, they typically eat out more often and it becomes a supply and demand issue.

But this time around, the outperformance seems to have continued long past the end of the recession (if it really did, in fact, end). This has occurred during a period of extended high unemployment numbers, and the lowest labor force participation rates we've seen in decades.

Commodity cost inflation, which would force either higher menu prices or lower margins, has not yet reared its ugly head in a significant way, although I still believe it ultimately will. It appears that one of our greatest pastimes as a nation is eating outside the home -- good economy or bad.

As a result, restaurant stocks have been on fire again this year. Year to date, a basket of 39 restaurant stocks, with a minimum market cap of $100 million, are up an average of 39.2%, versus 19.8% for the S&P 500, and 24.3% for the Russell 2000, which is the better benchmark -- given that the average market cap for the basket is about $1.3 billion.

But valuations for the group appear to be getting stretched out, with an average price-earnings ratio just above 30 and price-to-book ratio at 4. That's not to say restaurant stocks are on the verge of a meltdown, but they certainly are not cheap, and would likely get hit hard if the economic "recovery" (if you can call it that) loses steam, and/or if we see food costs rise substantially. These names would also likely be hit harder than the broad markets if we see a market pullback.

The biggest winner year to date is fast-casual name Fiesta Restaurant Group (FGRI), which went public in 2012 and operates Pollo Tropical and Taco Cabana restaurants in six states, primarily Texas and Florida. Last month, the company opened its 100th company-owned location.

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