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Can McDonald's Repeat As the Dow's Best Stock This Year?

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Last year, the Golden Arches had a banner year, leading all 30 Dow (INDEX: ^DJI  ) companies. As the Dow gained a modest 5.5% (before dividends), McDonald's (NYSE: MCD  ) gained 30.7%.

After tanking earlier in the decade, McDonald's stock has been on quite the run. It's the ninth straight year McDonald's stock has ended the year higher than it began. Think about that. After eight straight winning years that spanned a recession, McDonald's stock popped 30%!

The first thing that pops into my head is "Is McDonald's now overpriced? Will it be the Dow's worst stock in 2012?"

To help answer that, let's see what happened in the past nine years. During the run, it increased focus on its core chain by splitting off Chipotle (NYSE: CMG  ) and ridding itself of Donato's Pizza and Boston Market.

Meanwhile, its operational numbers improved in an astounding way. Since the end of 2002, its gross margins have increased from 30% to 40%, its net income has increased from 6% to 20%, and its return on capital has increased from 9% to 20%.

Given this, it's not surprising that McDonald's has been on such a tear. But we still haven't answered whether McDonald's is overpriced and due for a fall. Let's see where McDonald's and the competition are priced.

Although Wendy's (NYSE: WEN  ) is probably its closest public competitor, it's struggling enough where comparisons with McDonald's aren't helpful. Instead, let's look to Yum! Brands (NYSE: YUM  ) , owner of Taco Bell, Pizza Hut, and Kentucky Fried Chicken, for a comparison.

Both of them have strong operations. We can debate which is stronger (McDonald's has better margins, Yum! has better returns on capital, and both are expanding well globally), but it's like pitting Coke against Pepsi. We're parsing quality.

We see that the market appreciates that quality, assigning them each forward price multiples just south of 20.

Critics will point to increased health awareness as a possible danger, but I'm impressed with McDonald's ability to evolve and execute. Given its rich valuation, I wouldn't pick McDonald's to lead the Dow again this year, but I also wouldn't pick it to lead the Dow's losers.

As a shareholder myself, I'm torn between the slightly elevated multiples and the quality of McDonald's operations and continue to hold for now.

So no bold declarations from me about McDonald's fate in 2012. Instead, I'll leave the bold prediction to our chief investment officer. He identified one company as the No. 1 stock for the next year. Find out which stock in our brand-new free report: "The Motley Fool's Top Stock for 2012." I invite you to take a copy, free for a limited time. Just click here to access the report and find out the name of this legendary company.

Anand Chokkavelu owns shares of McDonald's. The Motley Fool owns shares of Yum! Brands and Chipotle Mexican Grill. Motley Fool newsletter services have recommended buying shares of Yum! Brands, Chipotle Mexican Grill, and McDonald's. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (2) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 16, 2012, at 3:49 PM, GordonsGecko wrote:


  • Report this Comment On January 16, 2012, at 5:53 PM, rd80 wrote:

    Hi A,

    I'm also an MCD shareholder and agree that the valuation looks a bit rich, but not so high that I want to sell.

    What are your thoughts on selling out of the money covered calls against MCD?

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Related Tickers

10/21/2016 4:47 PM
^DJI $18145.71 Down -16.64 -0.09%
MCD $113.93 Up +3.36 +3.04%
McDonald's CAPS Rating: ***
CMG $411.94 Up +6.84 +1.69%
Chipotle Mexican G… CAPS Rating: ****
YUM $86.97 Up +0.77 +0.89%
Yum! Brands CAPS Rating: ****