BUSI 532 Week 8 Group Project Example

Texas Roadhouse, Inc.: A Comprehensive Financial Statement Analysis and Valuation

Summary of Findings

Texas Roadhouse, Inc. is a highly profitable, debt-free restaurant company whose profitability fell in 2025 for reasons that appear largely cyclical. Return on net operating assets (RNOA) declined from 40.2 percent in 2024 to 33.2 percent in 2025, mainly because commodity inflation, led by beef, cut the operating margin. Free cash flow after acquisitions was $234.5 million, less than the $339.5 million the company distributed, which reduced its cash. A residual operating income valuation at a 9 percent cost of capital and 4 percent long-run growth gives about $119 per share, but reasonable alternative assumptions produce values from about $88 to $190. The group's conclusion is that the business is excellent and that the investment decision depends almost entirely on the growth an investor is asked to pay for.

The Business and Its Strategy

Texas Roadhouse operates and franchises casual dining restaurants under three concepts. At the end of fiscal 2025 there were 816 restaurants, 714 owned by the company and 102 franchised, in 49 states, one U.S. territory and ten foreign countries; of the company restaurants, 648 were Texas Roadhouse, 56 were Bubba's 33 and ten were Jaggers (Texas Roadhouse, Inc., 2026). The strategy is to make each restaurant a moderately priced local favorite, with steaks cut in-house, and to grow by opening new restaurants and by buying back franchised ones. In 2025 the company acquired franchise restaurants for $107.5 million, adding $72.5 million of goodwill. Penman (2013) argues that analysis begins with knowing the business, and two features of this one shape the numbers that follow: beef is the largest single cost exposure, and most restaurants are leased.

Reformulated Balance Sheets

As Penman (2013) recommends, the group classified cash as a financial asset and finance lease liabilities as financial obligations; the company had no borrowings outstanding at either year-end. Operating lease liabilities were treated as operating, consistent with treating the right-of-use assets as operating assets, which means the leases net against each other within net operating assets (NOA). Many analysts would instead treat the $974.0 million of lease liabilities at the end of 2025 as debt; we return to that choice under risk.

NOA plus NFA equals total equity in both years, so the reformulation reconciles to the filing. One operating liability deserves notice. Unredeemed gift cards, reported as contract liabilities, reached $448.7 million at the end of 2025: customers had in effect lent the company that amount at no interest, which lowers NOA and raises RNOA.

Reformulated Income Statements

Equity income from unconsolidated affiliates is operating, because those affiliates run restaurants. Interest income is financial. Taxes were allocated by assigning a 25 percent marginal rate to net interest income, roughly the 21 percent federal rate plus state taxes, and attributing the rest of reported tax expense to operations.

Comprehensive income equals net income here because the company reported no other comprehensive income, so the clean-surplus relation holds without adjustment.

Profitability Analysis

Return on equity is below RNOA because the company holds net financial assets that earn far less than its operations, a negative financial leverage effect of about four percentage points in 2025. The decline in RNOA came mostly from the margin, which fell 1.2 points as commodity inflation of 6.1 percent and labor inflation of 3.7 percent outran menu pricing (Texas Roadhouse, Inc., 2026). Turnover fell only slightly, partly because acquired franchise restaurants added goodwill to NOA. The business did not become less efficient in 2025; it paid more for beef. Across thousands of firm-years, Nissim and Penman (2001) found RNOA drifting back toward normal levels over time, and a margin squeezed by a commodity cycle is a likely candidate to recover partly, though the group does not assume it will.

Sustainable Earnings

Three items complicate the comparison. First, fiscal 2024 had 53 weeks, and the extra week added $114.7 million of revenue, so 2025's reported revenue growth of 9.4 percent understates the underlying rate; store weeks rose 5.0 percent and comparable restaurant sales 4.9 percent at company restaurants. Second, 2025 equity income included a $2.2 million gain on acquiring six affiliates, which will not recur. Third, the effective tax rate was only 13.8 percent, largely because of a $49.7 million credit for employer Social Security taxes paid on employees' tips; this credit has recurred for years and the company expects a 14 to 15 percent rate in 2026, so the group treats it as sustainable while noting that it depends on tax law.

Accounting conservatism also matters. Pre-opening costs of $27.5 million and all brand-building spending were expensed, and the brand itself appears nowhere on the balance sheet. Penman and Zhang (2002) showed that when a conservatively accounting firm grows its investment, current earnings are depressed and reserves build up, while slower investment releases them. Part of Texas Roadhouse's very high RNOA reflects assets that accounting does not record, which is why the group values the company from residual income rather than from book value alone.

Cash Flow and Payout

Distributions of $339.5 million exceeded 2025 free cash flow by about $105 million, and cash fell by $110.5 million. That is sustainable for a short period given the company's net financial assets and its revolving credit facility, but not indefinitely. The dividend rose from $2.44 to $2.72 per share, and the board authorized a $500 million repurchase program in February 2025. As Penman (2013) stresses, these distributions do not create value; they return value that operations created.

Forecast and Valuation

The group forecast 2026 using Penman's residual operating income model. Revenue grows 7 percent, combining the company's expectation of 5 to 6 percent store-week growth with modest pricing; the margin stays at the 2025 level of 7.0 percent; and the required return on operations is 9 percent, reflecting the company's lack of debt and its moderate operating risk. Forecast OI is $440.3 million. The charge for capital is 9 percent of beginning NOA of $1,349.7 million, or $121.5 million, which leaves residual operating income of $318.8 million. With residual income growing 4 percent a year after 2026, the value of operations is NOA plus $318.8 million divided by 0.05, or $7,725.6 million. Adding NFA and subtracting noncontrolling interests at book value gives equity of $7,836.7 million, or about $119 per share on 65.9 million shares.

Frankel and Lee (1998) found that the ratio of residual-income value to price predicted long-run stock returns, which supports using such a model to judge a price rather than to forecast one exactly. The grid can also be read in reverse. At a 9 percent required return, any market price above about $143 per share implies that residual operating income will grow faster than 5 percent a year forever, a strong assumption for a company that already operates in 49 states. The group recommends that an investor compare the current price with this grid on the day of the decision.

Risk

Three risks stand out. Operating risk comes from commodity and labor costs, which moved the margin by more than a point in a single year. Lease obligations of $974.0 million are fixed commitments that a downturn would not reduce; treated as debt, they would turn the company's net financial assets into net obligations and make the balance sheet look far more indebted. Valuation risk is the largest: Fama and French (1997) found that estimates of the cost of equity even for whole industries carried standard errors of more than 3 percentage points a year, and the grid shows that moving the required return by a single percentage point changes the value by about 15 to 25 percent. Penman (2013) frames this as the risk of paying too much, and it is the main risk an investor in this company controls.

Conclusion

Texas Roadhouse earns returns far above any reasonable cost of capital, carries no debt and generates enough cash to fund growth and steady payouts, though 2025's distributions ran ahead of free cash flow. Its 2025 decline in profitability came from the margin rather than from efficiency, and much of the margin pressure appears cyclical. On the group's base assumptions the shares are worth about $119, and the valuation is most sensitive to the long-run growth rate. The group's recommendation is therefore conditional: the company is a strong business, and it is a good investment at prices that do not require growth above about 4 to 5 percent a year.

References

Fama, E. F., & French, K. R. (1997). Industry costs of equity. Journal of Financial Economics, 43(2), 153-193. https://doi.org/10.1016/S0304-405X(96)00896-3

Frankel, R., & Lee, C. M. C. (1998). Accounting valuation, market expectation, and cross-sectional stock returns. Journal of Accounting and Economics, 25(3), 283-319. https://doi.org/10.1016/S0165-4101(98)00026-3

Nissim, D., & Penman, S. H. (2001). Ratio analysis and equity valuation: From research to practice. Review of Accounting Studies, 6(1), 109-154. https://doi.org/10.1023/A:1011338221623

Penman, S. H. (2013). Financial statement analysis and security valuation (5th ed.). McGraw-Hill Education.

Penman, S. H., & Zhang, X.-J. (2002). Accounting conservatism, the quality of earnings, and stock returns. The Accounting Review, 77(2), 237-264. https://doi.org/10.2308/accr.2002.77.2.237

Texas Roadhouse, Inc. (2026). Annual report on Form 10-K for the fiscal year ended December 30, 2025. U.S. Securities and Exchange Commission. https://www.sec.gov/Archives/edgar/data/1289460/000110465926021292/txrh-20251230x10k.htm