A Board Member Loves This Restaurant Stock

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Robert Walter, a member of Yum! Brands' (NYSE: YUM) Board of Directors, bought 35,000 shares of the stock on Feb. 6 at an average price of $61.95 per share. This purchase came shortly after a disappointing report from the restaurant company, whose three core brands are Pizza Hut, KFC, and Taco Bell. While last quarter was not particularly bad--net income was down 5% from its levels a year earlier and a small increase in revenue--Yum expects to report a decline in earnings this year as the Chinese business underperforms. The company claims that this is due to supply issues which would be resolved within a year, putting Yum back on track, but the stock has seen a number of downgrades including from Goldman Sachs.

The insider purchase, and a substantial one at that, shows that at least one insider is very confident in Yum’s prospects. Insiders should hesitate before buying shares, since it reduces their diversification, unless they think that the potential gains are high enough and certain enough to overwhelm the benefits of diversifying their wealth. Studies show that stocks bought by insiders tend to narrowly outperform the market (learn more about studies on insider trading).

With its iffy fourth quarter in the books, Yum! Brands trades at 19 times trailing earnings. That shows that even after the decline in the stock price, the market is expecting high growth rates over time as Yum capitalizes on its decision several years ago to focus on the Chinese market and other developing countries. Analyst consensus for 2014--after the company expects its business to be back on track--implies a forward P/E of 17. We’d say that this is a very bullish outlook, and we certainly wouldn’t consider Yum a value stock at these levels. It might be best to wait out a few quarters and see how its recovery progresses.

While hedge funds and other notable investors were pulling out of Yum! Brands during the third quarter of 2012, it still made our list of the most popular restaurant stocks among hedge funds (see the full top ten list). Billionaire Steve Cohen’s SAC Capital Advisors increased its stake by 55% during the quarter and closed September with 1.5 million shares in its portfolio (check out Cohen's stock picks). Chilton Investment Company, which is managed by fellow billionaire Richard Chilton, cut its stake slightly but still reported a position of about 640,000 shares.

Yum is best compared to other large quick service restaurants including McDonald’s (NYSE: MCD), Burger King (NYSE: BKW), Domino’s Pizza (NYSE: DPZ), and Chipotle (NYSE: CMG). In general, Yum’s earnings multiple is actually a discount to those of its peers. For example, Domino's carries a trailing P/E of 26 despite very limited revenue growth in its most recent quarter compared to the same period in the previous year (though earnings were up considerably). Chipotle is even more expensive (even its current-year earnings multiple is more than 30), but of course it is an enormously popular restaurant boasting high growth on both top and bottom lines. The recently public Burger King is valued at 23 times analyst consensus for 2013, making it another restaurant stock that looks more expensive than Yum.

Really the exception to this rule (if we ignore, for example, many table service restaurants) is McDonald's. That stock carries trailing and forward P/Es of 18 and 15, respectively, just a bit under Yum’s earnings multiples. McDonald's has also reported its results for the fourth quarter of 2012, recording small rises in both sales and net income, and it does not seem to have the same supply problems as Yum. While as a larger business it does have fewer growth prospects, this has left it with a higher market cap, and as a cash machine the stock pays a dividend yield of over 3%.

It’s interesting to see an insider purchase shares on the belief that the market is not giving Yum enough credit for its long term business, but we would still avoid the stock. Despite its discount to some other quick service restaurants, it does seem priced too high on an absolute basis for now. McDonald's appears to be a better choice for a value investor.

This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool recommends Burger King Worldwide, Chipotle Mexican Grill, and McDonald's. The Motley Fool owns shares of Chipotle Mexican Grill and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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