How to make dough from pizza businesses

Food and beverage investments can be some of the best you ever make.

Tom Richardson

Tom is a holder of the CFA Society of the UK administered Investment Management Certificate (IMC) and has more than a decade's professional experience in the investment management industry in Australia and the UK. Tom now works as a writer and editor for TMF Australia and has two easy to remember rules of investing he likes to follow. Avoid overpaying for growth stocks and avoid paying at all for stocks that are cheap for a reason. Tom prefers growth investing over value investing and says it's not rocket science, just avoid overpaying for the best returns.

Published January 9, 2014 1:30 pm AEDT

Investing in the food and beverage industry can be an attractive proposition. Some of the world's largest companies were once start-up operations themselves. Think of household brands like Coca-Cola (NYSE: KO), Starbucks (NASDAQ: SBUX) or McDonalds (NYSE: MCD) and you see just how much potential a seemingly small food and beverage business may have with winning recipes and brands.

While pizza, coffee, cake and donuts may sound like heaven to many, it's actually a place on earth for Retail Food Group (ASX: RFG) owners. Australia's largest multi-brand franchisor has interests in Michel's Patisserie, Brumby's Bakeries, Donut King, Pizza Capers, Crust Gourmet Pizza and The Coffee Guy. Net profit after tax was up 12.1% to $32 million in financial-year 2013 and the group has generated a record profit every year since 2001. The pizza businesses have grown strongly and have the potential to go much further. The group trades on a fully franked dividend yield of 4.4% and I think looks a strong prospect to keep delivering future growth.

The Domino's Pizza (NYSE: DPZ) brand was established in the United States way back in 1960. It's now the largest pizza franchise worldwide and Domino's Pizza (ASX: DMP) is the ASX-listed holder of master franchise rights for Australasia and large parts of Europe. The company has grown strongly thanks to its low-cost pizzas, strong brand and all-round popularity. It now also has a 75% interest in Domino's Pizza Japan. While the pizzas are cheap the shares aren't. At its October annual meeting the company confirmed that it expects financial-year 2014 earnings growth to be in the region of 15% (excluding non-recurring Japanese acquisition and integration costs). This week the shares are trading at 52-week highs and are up more than 25% since October. It's currently trading on an eye-watering forward price-to-earnings ratio of approximately 33. The group has a recipe that works, but the presumption of fast growth is well and truly priced into the shares, so investors should be aware that anything else could see a big price tumble.

Foolish takeaway

You don't have to be a financial whiz to understand what people like is often the very basis of a company's earnings. On a long-term horizon, companies with winning recipes tend to deliver market-beating returns to investors who are not too hungry for instant returns.

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