An industry that has never ceased to entice is food. And when it comes to fast food, people have an undying love for juicy burgers, appetizing pizzas, grilled sandwiches, delicious ice creams, and the likes.
 
However, so far in 2016, same-store sales growth has been rather dull in the restaurant space, given the difficult sales environment. Despite economic growth, somewhat lower energy prices, and higher income, consumers have increased their spending only modestly on dining out, which has resulted in low consumption over the last few months. Moreover, unfavorable currency and a tightening labor market have compounded restaurateurs’ woes. Traffic has been weak as well.

Nonetheless, according to the National Restaurant Association, 2016 could well be the seventh consecutive year of real sales growth in the restaurant industry. Notably, the industry’s sales account for 4% of the U.S. GDP. Meanwhile, restaurateurs are countering comps and traffic issues with strong sales, digital initiatives and by adapting to the shifts in consumers’ taste.
Moreover, the Restaurant Performance Index (RPI), which tracks the health and outlook of U.S. restaurants, was at 100.8 in September, up 1.2% from August, per the National Restaurant Association.

Q3 so Far
 
The restaurant industry belongs to the broader Retail-Wholesale sector. Per the latest Earnings Outlook, as of Nov 2, 37.2% of the retail companies in the S&P 500 index have reported their results. We note that the beat ratios for this sector have been average (43.8% for earnings and 25% for revenues).
 
Turning our focus to the restaurant stocks, it is to be noted that a soft consumer spending environment in the U.S. restaurant space, which is leading to lower traffic and comps, is turning out to be a major headwind for the top line in third-quarter 2016.
 
This is evident by the results of two key players, Chipotle Mexican Grill, Inc.(CMG) and BJ’s Restaurants, Inc. (BJRI) whose earnings and sales missed estimates. Meanwhile, though Yum! Brands, Inc.’s (YUM) earnings were in line with the Zacks Consensus Estimate, revenues failed to surpass the same.
 
However, beating the sluggish trend, restaurant behemoths like McDonald’s Corporation (MCD), Domino’s Pizza Inc. (DPZ) and Papa John’s International, Inc. (PZZA) posted robust results beating earnings and revenue estimates on the back of strong fundamentals and strategic initiatives.
 
Moreover, there are other companies in the space as well that are expected to stand tall in spite of the recent chaos, suggesting that investors should not shy away from investing in this space.

How to Pick the Right Stocks?
 
Picking the right stock for your portfolio could appear to be a daunting task given the wide range of companies in the restaurant space. One way to confine the list of choices this earnings season is by looking at stocks that have a solid Zacks Rank accompanied by a favorable Earnings ESP.
 
Earnings ESP is our proprietary methodology for determining which stocks have the best chance to pull a surprise in their next earnings announcement. It shows the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate.
 
The combination of a favorable Zacks Rank – Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) – and a positive Earnings ESP is usually an indication of an earnings beat. Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as high as 70%. Please check our Earnings ESP Filter that enables you to find stocks that are expected to come out with earnings surprises.
 
For investors seeking to apply this strategy to their portfolio, we have highlighted two restaurant stocks that may stand out this season.
 
Based in Texas, Dave & Buster's Entertainment, Inc. (PLAY - Free Report) began trading in Oct 2014. The core concept of the restaurateur is “Eat Drink Play and Watch”, all in one location. Its menu comprises “Fun American New Gourmet” entrées and appetizers and a full selection of non-alcoholic and alcoholic beverages. Strong sales, earnings growth and significant margin improvement are expected to boost results in the to-be-reported quarter.

Dave & Buster's posted a 13.64% positive earnings surprise in the previous quarter. Moreover, the company’s earnings surpassed the Zacks Consensus Estimate in each of the last four quarters, with an average beat of 89.73 %.
 
That said, for the upcoming release, Dave & Buster's has an Earnings ESP of +15.39% and a Zacks Rank #3. The Zacks Consensus Estimate for the quarter’s earnings is pegged at 13 cents per share.
 
 The company is expected to report third-quarter results on Dec 13, after market close.
 
The Wendy's Company’s (WEN - Free Report) sales initiatives like menu innovation and promotional offerings along with increased investments in technology should drive third-quarter results.  
 
Wendy’s registered a positive earnings surprise of 11.11% in the last reported quarter. In fact, the company surpassed the Zacks Consensus Estimate in each of the trailing for quarters, with an average beat of 29.01%.
 
For the quarter to be reported, the company has an Earnings ESP of +10.00% and a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
 
The Zacks Consensus Estimate for the quarter’s bottom line is pegged at 10 cents.
 
The company is set to report third-quarter results before the opening bell on Nov 9.
 
To Sum Up
 
Though the restaurant industry has its share of pitfalls, effective sales initiatives undertaken by the companies have kept it going. We thus believe that investing in these companies, with an earnings beat potential on strong fundamentals, could yield strong returns for your portfolio in the near term.