As the world's third-richest person and most celebrated investor, Warren Buffett attracts a lot of attention. Thousands try to glean what they can from his thinking processes and track his investments.
We can't know for sure whether Buffett is about to buy McDonald's (NYSE: MCD ) -- he hasn't specifically mentioned anything about it to me -- but we can discover whether it's the sort of stock that might interest him. Answering that question could also reveal whether it's a stock that should interest us. In this series, we do just that.
Writing in a recent 10-K, Buffett lays out the qualities he looks for in an investment. In addition to adequate size, proven management, and a reasonable valuation, he demands:
- Consistent earnings power.
- Good returns on equity with limited or no debt.
- Management in place.
- Simple, non-techno-mumbo-jumbo businesses.
Does McDonald's meet Buffett's standards?
1. Earnings power
Buffett is famous for betting on a sure thing. For that reason, he likes to see companies with demonstrated earnings stability.
Let's examine McDonald's earnings and free cash flow history:
Source: S&P Capital IQ.
Over the past five years, McDonald's earnings and free cash flow have grown rapidly.
2. Return on equity and debt
Return on equity is a great metric for measuring both management's effectiveness and the strength of a company's competitive advantage or disadvantage -- a classic Buffett consideration. When considering return on equity, it's important to make sure a company doesn't have an enormous debt burden, because that will skew your calculations and make the company look much more efficient than it is.
Since competitive strength is a comparison between peers, and various industries have different levels of profitability and require different levels of debt, it helps to use an industry context.
|
Company
|
Debt-to-Equity Ratio
|
Return on Equity
|
5-Year Average Return on Equity
|
| McDonald's |
94% |
40% |
26% |
| Yum! Brands |
155% |
67% |
122% |
| Wendy's |
68% |
0% |
(6%) |
| Jack in the Box |
115% |
17% |
21% |
Source: S&P Capital IQ.
McDonald's generates high returns on equity while employing a reasonable amount of leverage.
3. Management
CEO James Skinner has been at the job since 2004. Before that, he held many other positions at McDonald's for more than three decades.
4. Business
Fast food isn't particularly susceptible to technological disruption.
The Foolish conclusion
So is McDonald's a Buffett stock? It could very well be. The company exhibits many of the quintessential characteristics of a Buffett investment: consistent or growing earnings, high returns on equity with limited debt, tenured management, and a straightforward business. If you'd like to stay up to speed on McDonald's progress, simply add it to your stock watchlist. If you don't have one yet, you can create a watchlist of your favorite stocks.
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