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Your First Date with a Potential Investment
Course Section 3 - Lesson 2
Once you've constructed a list of potential investment options, it's time to establish whether any of the companies on that list are worthy of investment. Making this determination will involve several steps, which we'll walk through over the remain lessons in Section 3. To assist us in driving home the work we will be doing; we will be analyzing the company Texas Roadhouse, ticker symbol TXRH.
The first step in this process is to understand how the company operates and how its customers perceive its products and services.
To accomplish this, we'll be doing some internet sleuthing. Along the way, we'll need to find company filings, conference calls, news articles, and hopefully comments/blog posts from genuine customers.
Before we dive into what we're looking for in the information we collect, I first want to talk about where we find it.
Edgar - sec.gov
The first information source we will be utilizing is Edgar, the Security and Exchange Commission's tool for aggregating and disseminating company filings. The home page for Edgar, which can found here, conveniently positions a company search box front and center on their homepage. By typing in a company's name or ticker symbol, we are taken to a page displaying all of the company's filings. The ones we are primarily interested in are the 10K and 10Q filings.
Company Investor Relations Page
Most publicly traded companies will host an investor relations page, which will provide easy access to glossy annual reports and company conference call recordings. You can typically find links to these pages on a company's homepage or by simply googling "<company name> investor relations". To get an idea of the information on these pages, check out Texas Roadhouses' investor relations page.
There are many outlets to find company news. Still, one of my favorite sources to get a list of all company headlines regardless of the originating outlet is Google News. This tool allows you to search by company name and period to quickly see what stories are talking about the company.
Google / Amazon / Social Media
When it comes time to assess how customers feel about a company, we can turn to any sites that allow real people to post their thoughts about company products and services.
Answering the Important Questions
Using these free data sources, we seek to answer fundamental questions about what the company does and how stable its competitive position in the industry is.
Let's walk through this process for Texas Roadhouse.
Start with a 10K Read-Through
The first step when reviewing a company is reading its most recent Annual SEC filing (10K) from the Edgar website.
It can be intimidating the first time you read one of these documents; they are usually pretty long, 100+ pages, and contain many cryptic tables. But after you read a couple of them, you begin to see that they all follow a relatively similar format: First, in Part 1, they discuss how the company's business operates, then, in Part 2, management of the company provides their interpretation of the most recent periods results, finally in parts 3 & 4 corporate governance issues will be reviewed and the company will provide complete financial statements (or links to financial statements).
Parts 1 & 2 offer the most value when you're doing your initial evaluation. In these sections, we discover that Texas Roadhouse is a restaurant operator that runs about 640 restaurants across the United States. Each restaurant costs about $6.2 million to open, and once a location is open, it generates about $4.6 million in annual sales. Additionally, we see that while Texas Roadhouse does own and operate a majority of its restaurants, it also franchises about 100 others. Finally, if we deduct food, labor, rent, and other operating expenses from total revenue, we can see that each restaurant generates about 17 cents of income for every dollar of sales.
At this point, we have a pretty good understanding of what Texas Roadhouse does. We can roughly estimate how much revenue the company generates each year: Total Number of Restaurants x Avg. Sales per Restaurant or ~$3 billion. And how much operating profit the company earns: $3 billion x 17% or $500 million.
From here, we can start to formulate some of the more important questions that we are going to need to answer later on in the process:
How consistent are the company's sales?
What levers can the company pull to increase sales?
For every dollar of sales, how much profit does the company generate?
Is there room for the company to expand its current level of profitability?
Are there any significant risks to the company's business model?
What is happening in the News?
While the annual report is an excellent source of information on the company, it often fails to provide a sense of its immediate challenges. To fill in these gaps, we turn to google News.
As you might expect, given that Texas Roadhouse is a restaurant, we see many news stories that discuss the challenges of the restaurant sector during the Covid-19 pandemic. We should note this and keep it in mind when we later analyze its financial results during the pandemic period.
Additionally, we also see stories discussing the recent death of the company's CEO and Founder. This is a major event for the company and can potentially change the company's trajectory. As we continue to research Texas Roadhouse, we want to keep this unexpected leadership change at the front of our minds to make an informed decision about how it will affect the company's future.
Investor Relations Page
Now that we have a general sense of what the business is and what headlines the company has been making, it's often helpful to hear management's take on recent company performance and its current outlook.
A great way to gather this information is by listening to the quarterly conference calls that nearly all companies host and save to their investor relations websites.
These calls usually start slowly as the management team walks through prepared comments; however, the Q&A portion of the call is very informative. For one, professional investment analysts are asking the questions, so you can get a sense of what investors on Wall Street are thinking about the company, and two, the answers that company management provides to the questions are usually pretty candid, and it's information that can't be found anywhere else.
For Instance, on the Q4 2020 Texas Roadhouse call, we heard that:
To-go orders are skyrocketing as a percentage of total sales. Even though the company is happy to accept these orders, profit margins on to-go orders are lower than in-house, mainly due to a lack of alcohol sales to-go.
Texas Roadhouse expects the mix of in-house and to-go to normalize throughout 2021, allowing margins to expand.
The late CEO, Kent Taylor, stated that he expected the current rate of new restaurant openings (25-30 new locations each year) to continue for "many" years.
What are Customers Saying?
Finally, the last overview piece of information that we want to gather is a high-level understanding of how customers view the Texas Roadhouse brand.
Yelp is a primary aggregator of restaurant reviews. If you search for Texas Roadhouse on Yelp, we see that the restaurant has a 4.0 out of 5 rating across 3,000+ reviews, which is high for a chain restaurant.
Similarly, when I search for Texas Roadhouse on Reddit, most of the results are positive threads (especially about the bread), indicating positive emotions associated with the brand.
These two data points are enough to give me enough confidence at this point the customers view the restaurant positively.
Digesting What We've Learned
In an initial company review, our goal is to develop a sense of what a business does, how well it's doing it, what opportunities or land mines lay in its future, and how its customers feel about its brand.
In just a few hours of work we can accomplish this using completely free resources.
For Instance, with Texas Roadhouse, we've gone from a simple understanding that the company runs restaurants to knowing that the chain runs 640 dining rooms across the US with plans to open 25-30 new locations each year. We know that each location the company opens costs about $6 million to open then generates a million dollars a year in income for investors. We know that the customers that patronize Texas Roadhouse have positive feelings about their experience with the brand. These are all strong signals that an investment opportunity may exist within TXRH stock. However, there are some pitfalls that we need to watch out for.
The fact that the company's founder and CEO passed away this year could negatively affect operations going forward. On top of that, we are still in a global pandemic, and restaurants, in particular, rely on customers visiting their locations in person. We will have to come to terms with these two immense challenges before we invest in Texas Roadhouse.
This first phase of analysis is simply about understanding. While Texas Roadhouse is an attractive company that warrents further analysis, we could have just as easily dug into a company that was a complete dud: One whose business lines were failing, revenue was declining, and whose customers abhored it. In such a case just move on.
For now, we'll continue to dig deeper into Texas Roadhouse.