Riding the Chain-Store Growth Wave

As our ballooning trade deficit indicates, the U.S. is a consumer-driven society. Feeding the voracious appetite of the American consumer are chain-store operators, both traditional names like McDonald's and Wal-Mart, and more trendy operators like Starbucks and Whole Foods. These familiar brands bring us convenience, efficiency, lower prices and (ironically) even some sense of new cultural belonging.

By the very nature of their bricks-and-mortar, consumer-driven businesses, successful chain-store operators show steady, largely predictable growth over many years. As examples, I summarize historical and look-ahead operating financials of some of the well-known names:

Company (Ticker): Number of Stores; Historical 2000-2004 Annual % Growth in: Number of Stores, Sales, Net Profit

Wal-Mart (WMT): 5,170; 5.5%, 12.0%, 13.1%
Home Depot (HD): 1,890; 13.6%, 12.5%, 17.8%
McDonald's (MCD): 31,130; 2.0%, 7.6%, 3.6%
Starbucks (SBUX): 8,570; 25.1%, 25.0%, 42.5%
Whole Foods (WFMI): 163; 8.6%, 20.4%, 26.3%
Tuesday Morning (TUES): 662; 11.3%, 11.2%, 26.3%

Company (Ticker): Mkt. Cap., Fwd. P/E, Consensus 5-Yr. Earnings Growth Rate, PEG

Wal-Mart (WMT): $220 bil., 16.8, 14%, 1.20
Home Depot (HD): $87 bil., 13.8, 13%, 1.06
McDonald's (MCD): $41 bil., 16.1, 8.5%, 1.89
Starbucks (SBUX): $21 bil., 44.5, 22%, 2.02
Whole Foods (WFMI): $6.6 bil., 40.0, 20%, 2.00
Tuesday Morning (TUES): $1.2 bil., 16.9, 20%, 0.84

Basic growth patterns among these successful chain-store operators are:

1. The number of chain stores increases each year;

2. The increase in sales is at a rate comparable to or faster than the increase in the number of stores, indicating little to no sales cannibalization of older stores by newer stores;

3. Earnings typically rise faster than sales, exhibiting efficiency of scale.

The strong fundamental growth of the chain stores drives their stock prices higher over the long run. With McDonald's celebrating its 50th anniversary this year and still growing, the outlook appears bright for the other chain stores, which are all much younger than McDonald's.

My own quick assessment of the investment opportunity in these particular companies at this point is (in approximate order of lowest to highest business growth potential):

* McDonald's ("king" of fast food): Very mature both in U.S. and abroad. Some revival potential through a revised menu;
* Wal-Mart ("lowest price" model): Mature in U.S. International expansion opportunity;
* Home Depot (home improvement trend): Growth remaining in U.S. through further consolidation of fragmented home maintenance industry. Some growth opportunities abroad. Stock looks cheap (Disclosure: I am long HD);
* Tuesday Morning (quality at bargain prices): Continuing growth in U.S. Would be good bricks-and-mortar partner for Overstock.com. Stock looks cheap;
* Whole Foods (organic foods trend): Growth remaining as high income consumers shift their diet to healthier foods. Opportunity to extend price range downward to attract middle income customers and compete more directly with Trader Joe's (private). Stock looks expensive;
* Starbucks (urban gathering spot): Continuing growth in U.S. and abroad. Can easily add to menu. Ongoing value in catering to social needs of aging of baby-boomers. Stock looks expensive.

Since all of these names are already well-known, the best investment opportunities are likely to be found in younger yet-to-be-discovered chain-store operators who offer products and services as central to the needs, wants and desires of the American consumer as fast food. Out-sized "ten-bagger" rewards (a la Peter Lynch) await those prescient investors who are able to identify chain-store winners in their early years and ride the growth wave upward.