Published: October 8, 2009

I grew up in a diner. My parents have owned and operated Edelweiss restaurant in Auburn, Calif., for the better part of 30 years. I'm not a restaurant analyst, but I know first-hand how tough the business can be.

Studies show one in four restaurants close in their first year of business. Extend that to three years, and the failure rate rises to three in five.

When that first lease is up, many entrepreneurs realize that the restaurant business just isn't for them.

Then there are the exceptions that prove the rule: Great restaurants that really shine. These businesses juggle pleasing customers, keeping the food consistent, managing vendors, keeping the staff content, fixing refrigerators and a hundred other endless jobs.

Easy? No. But the operators who can do it make serious money. So can their shareholders.

The list of publicly traded U.S. restaurants -- 151 in all -- has a lot of well-known and well-loved restaurants, but many aren't making money.

Some are growing, but slowly, suggesting they may have reached the saturation point. McDonald's, as an extreme example, has so many U.S. stores that Americans are never more than 107 miles from one. There's always overseas, of course, though a lot of those markets have already been tapped.

Of the 151 restaurants listed on U.S. exchanges, only 68 have a market cap of more than $5 million. That's a teeny company in the big scheme of things, but it's Nasdaq's minimum, and for now, it's a decent starting point.

Next, let's weed out restaurants that have negative revenue growth for the past year. We want to see companies that have begun to grow, not some mom and pop -- like my mom's and my pop's -- that are happy with a few locations.

Having assured ourselves of top-line growth, we now look to the bottom line at earnings per share. We want to see growth. We don't just want more locations, we want more profitable locations. Tasty stocks doesn't translate into tasty burgers. The inverse is also true.

After sifting through market cap, revenue and earnings data, we've narrowed the list from 151 to nine:

These are all good operators. Now let's find out which one is the best.

I tightened the screen and excluded companies with less than 20% EPS and revenue growth during the past year. I eliminated any company with a forward P/E above 20, a price-to-book ratio above below 4.0, and excluded restaurants with a net profit margin of less than 5%.

Three companies remained: Buffalo Wild Wings, Panera Bread and Nathan's Famous.

The raw data shows these three restaurants to be the best in the business. Of the three, Buffalo Wild Wings is the clear winner. The chain combines chicken, beer and sports on TV. In fact, Nathan Slaughter profiled the company in depth in his most recent issue of Half-Priced Stocks. To learn more, click here.

 
-- Anthony Haddad
Staff Writer
StreetAuthority.com