Markets

Choosing Between Yum! Brands, Inc. (YUM) and Darden Restaurants, Inc. (DRI)

Yum! Brands, Inc. (NYSE:YUM) and Darden Restaurants, Inc. (NYSE:DRI) are the two most active stocks in the Restaurants industry based on today’s trading volumes. The market is clearly enthusiastic about both these stocks, but which is the better investment? To answer this, we will compare the two companies based on the strength of their growth, profitability, risk, returns, valuation, analyst recommendations, and insider trends.

Growth

Companies that can consistently grow earnings at a high compound rate usually have the greatest potential to create value for shareholders in the long-run. Analysts expect YUM to grow earnings at a 14.30% annual rate over the next 5 years. Comparatively, DRI is expected to grow at a 11.60% annual rate. All else equal, YUM’s higher growth rate would imply a greater potential for capital appreciation.

Profitability and Returns



Growth in and of itself is not necessarily valuable, and it can even be harmful to shareholders if companies overinvest in unprofitable projects in pursuit of that growth. We will use EBITDA margin and Return on Investment (ROI), which adjust for differences in capital structure, as measure of profitability and return. Yum! Brands, Inc. (YUM) has an EBITDA margin of 14.24%, compared to an EBITDA margin of 13.18% for Darden Restaurants, Inc. (DRI). This suggests that YUM underlying business is more profitable. YUM’s ROI is 36.40% while DRI has a ROI of 17.20%. The interpretation is that YUM’s business generates a higher return on investment than DRI’s.

Cash Flow 

The value of a stock is simply the present value of its future free cash flows. YUM’s free cash flow (“FCF”) per share for the trailing twelve months was -0.08. Comparatively, DRI’s free cash flow per share was +0.01. On a percent-of-sales basis, YUM’s free cash flow was -0.43% while DRI converted 0.02% of its revenues into cash flow. This means that, for a given level of sales, DRI is able to generate more free cash flow for investors.




Liquidity and Financial Risk

Liquidity and leverage ratios are important because they reveal the financial health of a company. YUM has a current ratio of 1.20 compared to 0.60 for DRI. This means that YUM can more easily cover its most immediate liabilities over the next twelve months.

Valuation

YUM trades at a forward P/E of 23.45, and a P/S of 7.12, compared to a forward P/E of 16.30, a P/B of 4.74, and a P/S of 1.40 for DRI. Given that earnings are what matter most to investors, analysts tend to place a greater weight on the P/E.

Analyst Price Targets and Opinions

Investors often compare a stock’s current price to an analyst price target to get a sense of the potential upside within the next year. YUM is currently priced at a -6.04% to its one-year price target of $79.37. Comparatively, DRI is -11.28% relative to its price target of $89.86. This suggests that DRI is the better investment over the next year.

The average investment recommendation on a scale of 1 to 5 (1 being a strong buy, 3 a hold, and 5 a sell) is 2.40 for YUM and 2.40 for DRI, which implies that analysts are equally bullish on their outlook for the two stocks.

Risk and Volatility

To gauge the market risk of a particular stock, investors use beta. Stocks with a beta above 1 are more volatile than the market as a whole. Conversely, a beta below 1 implies below average systematic risk. YUM has a beta of 0.81 and DRI’s beta is 0.24. DRI’s shares are therefore the less volatile of the two stocks.

Insider Activity and Investor Sentiment

The analysis of insider buying and selling trends can be extended to the aggregate level. Short interest, which represents the percentage of a stock’s tradable shares currently being shorted, captures what the market as a whole feels about a stock. YUM has a short ratio of 1.50 compared to a short interest of 6.34 for DRI. This implies that the market is currently less bearish on the outlook for YUM.

Summary

Darden Restaurants, Inc. (NYSE:DRI) beats Yum! Brands, Inc. (NYSE:YUM) on a total of 6 of the 12 factors compared between the two stocks. DRI is growing fastly and has a higher cash conversion rate. In terms of valuation, DRI is the cheaper of the two stocks on an earnings and sales basis, DRI is more undervalued relative to its price target. Finally, MGM has better sentiment signals based on short interest.

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