Since October 2024, Yum China has been in a holding pattern, posting a small loss of 1.7% while floating around $46.51. However, the stock is beating the S&P 500’s 7.8% decline during that period.

Is there a buying opportunity in Yum China, or does it present a risk to your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free.

Even with the strong relative performance, we don't have much confidence in Yum China. Here are three reasons why you should be careful with YUMC and a stock we'd rather own.

Why Is Yum China Not Exciting?

One of China’s largest restaurant companies, Yum China (NYSE: YUMC) is an independent entity spun off from Yum! Brands in 2016.

1. Long-Term Revenue Growth Disappoints

A company’s long-term performance is an indicator of its overall quality. Any business can put up a good quarter or two, but the best consistently grow over the long haul. Unfortunately, Yum China’s 5.2% annualized revenue growth over the last five years was tepid. This was below our standard for the restaurant sector.

2. Projected Revenue Growth Is Slim

Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite.

Over the next 12 months, sell-side analysts expect Yum China’s revenue to rise by 5.2%, close to its 5.2% annualized growth for the past five years. This projection is underwhelming and implies its newer menu offerings will not accelerate its top-line performance yet.

3. Low Gross Margin Reveals Weak Structural Profitability

Gross profit margins tell us how much money a restaurant gets to keep after paying for the direct costs of the meals it sells, like ingredients, and indicate its level of pricing power.

Yum China has bad unit economics for a restaurant company, signaling it operates in a competitive market and has little room for error if demand unexpectedly falls. As you can see below, it averaged a 18.6% gross margin over the last two years. That means Yum China paid its suppliers a lot of money ($81.39 for every $100 in revenue) to run its business.

Final Judgment

Yum China isn’t a terrible business, but it doesn’t pass our quality test. Following its recent outperformance in a weaker market environment, the stock trades at 17.9× forward price-to-earnings (or $46.51 per share). This valuation multiple is fair, but we don’t have much faith in the company. We're pretty confident there are more exciting stocks to buy at the moment. We’d suggest looking at one of Charlie Munger’s all-time favorite businesses.

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