In today’s episode, I will be discussing the Pros and Cons of Retail Chain Investing. This topic is particularly interesting for me right now as I have been studying multiple retail chains as potential investments this past month.
Key Points of Retail Chain Investing
Pros:
- A repeatable business model that can be easily copied across the nation for business growth
- If the business can cash fund new locations, then Return on incremental invested capital (ROIIC) can be high for a long period of time. (Self-Funding Growth)
- Chain stores build local and national brand equity as store density grows. Storefronts are inherent marketing.
- Margin growth over time due to economies of scale. The larger the chain grows, the more negotiating power they have with suppliers and the better the distribution network would be.
- The ability to franchise the business can create synthetic equity benefits for shareholders.
Cons:
- Operational leverage in the business causes retailers to have an inherently lower margin of safety than other businesses
- Debt should not be used on the balance sheet because lease agreements already provide sufficient leverage and large future liabilities.
- As the chain grows, branding can be a double-edged sword. Mistakes at one store can cause negative impacts on the entire chain (Fragility risk) (Ex: Chipotle with its foodborne illness problems)
- Retail chains have a growth phase and a stable phase. If you buy in the growth phase, you’re likely to experience P/E ratio compression as the retail chain finishes expanding to capacity. (A headwind that will cause your investment performance to lag behind the true performance of the business.)
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Show Notes available at DIYInvesting.org
The full show notes for this episode, including my outline for today’s podcast, are available at https://www.diyinvesting.org/Episode14
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