Yum! Brands, Inc.: This Formula Unlocks Explosive Investment Returns Income Investors 2019-11-20 09:07:45 Yum Brands Inc NYSE:YUM Yum! Brands Inc Yum stock Yum! Brands, Inc. (NYSE:YUM) can is a great way to teach about the Pareto principle, also known as the “80/20 rule.” Here's what it means for investors. Yum Stock https://www.incomeinvestors.com/wp-content/uploads/2019/11/crop-woman-using-calculating-machine-MZ9ZBJK-150x150.jpg

Yum! Brands, Inc.: This Formula Unlocks Explosive Investment Returns

What Yum! Brands, Inc. Can Teach Us About Investing

If you want to make more investment profits, then you need to understand this business formula: 80/20.

The “80/20 rule,” also known as the Pareto principle, states that 80% of the results come from 20% of the causes. In business, this means most of the money made in any industry comes from a tiny fraction of the activities. Smart companies exploit this principle by zeroing in on the 20% of their business that earns 80% of the profit. Then they leave the donkey work to others.

Case in point: Yum! Brands, Inc. (NYSE:YUM), the owner of “KFC,” “Taco Bell,” “Pizza Hut,” and “WingStreet.” At one point, the fast-food giant owned and operated more than 10,000 restaurants nationwide. But in 2016, CEO Greg Creed revealed plans to sell most of the company’s locations to franchisees. (Source: “Yum! Brands Details Transformation Plans,” Yum! Brands, Inc., October 11, 2016.

Now you may be wondering why any company would follow this strategy. By selling off its restaurants, Yum! Brands now has to let franchisees in on its profits. In fact, you can see this by taking a quick glance at the company’s financial results. Since 2016, Yum! Brands’ annual sales have dropped 11%.

Here’s where the 80/20 rule kicks in though. Owning and operating a restaurant is the worst part of the fast-food business. By franchising its locations, Yum! Brands outsourced a lot of its headaches. Now franchisees, not shareholders, have to front the cost of building new locations. Franchisees also have to deal with staff, customers,  renovations, and local regulators.

Yum! Brands, in the meantime, has picked out the best part of the business: branding and marketing. In other words, the 20% of activities that generate 80% of the profits.

Yum! Brands doesn’t have to hire staff. Yum! Brands doesn’t have to deal with customers. Yum! Brands doesn’t have to fork over more and more money to landlords and the electric company. Instead, executives can kick up their feet, collecting royalty checks on the sale of each meal.

This explains why we didn’t see a big drop in the company’s profits following the sale of its locations. In 2016, the company generated $1.6 billion in net income. Last year, this number dropped by about five percent to $1.5 billion.

But here’s the best part: By franchising its locations, Yum! Brands now has less money tied up in restaurants. That has freed up billions of dollars of capital, which management has used to buy back Yum stock. So while the business makes less money, its profits get divided up by fewer people.

This means every penny invested into the business earns far more than it did before. Or, as we like to say in the financial world, management is “making the equity sweat.”

You can see the changes highlighted in the table below. In 2016, Yum! Brands generated $4.11 in earnings per share. In 2018, this figure jumped to $4.80.

Metric 2016 2018
Revenue $6.4 Billion $5.7 Billion
Net Income $1.6 Billion $1.5 Billion
Outstanding Shares 394,000 322,000
Earnings Per Share $4.11 $4.80

(Source: “YUM! Brands, Inc. (YUM),” Yahoo! Finance, last accessed November 19, 2019)

Think of it like a pizza. A large pie divided 20 ways doesn’t yield a big slice for each person. But a medium pizza divided among only three people results in a decent meal.

Wall Street has done the math. Since Yum! Brands launched its franchising strategy, Yum stock has soared by 78%. That has crushed the returns from the broader S&P 500 and wider restaurant industry over the same period.

Moreover, management has boosted the quarterly distribution from $0.30 per share in 2017 to $0.42 today.

You can expect those returns to keep rolling in. By exploiting the 80/20 rule, Yum! Brands, Inc. has become a money machine. Executives also continue to sign up new franchisees overseas. That should allow them to boost profits without putting up much cash themselves.

That’s the power of the 80/20 formula.

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