This article is part of our Real Money Stock Picks series.
I'm channeling Warren Buffett for the next addition to my Real Money portfolio. The Oracle of Omaha is often quoted as saying, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price," and that's exactly what I'm doing today. I'm not claiming to reinvent the wheel with this stock pick, but I absolutely believe this company offers the kind of long-term returns investors should love.
McDonald's is the ultimate well-oiled machine as far as businesses go. The largest restaurant chain in the world by revenue, it's honed its model to the point where the performances of its locations blow the competition out of the water. Banking off a combination of incredible brand strength (more on that later), savvy restaurant locations, and highly consistent experience, its restaurants produce the best profits for per location in the restaurant industry. Consider this: The average McDonald's restaurant generates an average of $2.7 million in annual sales, putting the industry average of around $1 million to shame. Better yet, it applies this outstanding model on a truly massive scale. At the end of last year, McDonald's operated 33,510 restaurants throughout 119 countries, split between 27,075 franchised locations and 6,435 company-owned restaurants.
The franchising system itself is another key ingredient that drives McDonald's amazing economics. With more than 80% of its restaurants operating as franchises, McDonald's receives consistent, high-margin cash flows from franchise royalties and rents that are largely uncorrelated to the broader economy. Its size also gives the company outsized clout in dealing with its suppliers and securing it strong pricing for its locations. And while McDonald's is clearly a mature company, it's still aggressively pursuing growth opportunities. In fiscal 2012 alone, the company has plans to spend $2.9 billion to open more than 1,300 restaurants and remodel more than 2,400 existing restaurants.
And McDonald's refuses to rest on its laurels. The company consistently strives to improve the performance of its locations, even going as far as opening a 38,000-square-foot innovation center in Illinois that allows the company to unlock new breakthroughs to increase efficiency and profitability throughout the entire business. It's this kind of obsessive attention to detail that's enabled McDonald's to increase its same-store sales for a mind-boggling 109 consecutive straight quarters.
McDonald's instantly recognizable brand is another valuable arrow in its quiver. According to Interbrand's annual survey of brand strength, McDonald's owns the sixth most valuable brand in the world, an asset it spends nearly $770 million in marketing to support. Each of these factors allows McDonald's to put up some performance figures that leave its competition in the dust.
Gross Margin (TTM)
Net Income Margin (TTM)
Return on Equity (TTM)
|Yum! Brands (NYSE: YUM )||26.7%||11.7%||73.9%|
|Burger King (NYSE: BKW )||34.5%||5.9%||9.2%|
|Starbucks (Nasdaq: SBUX )||56.4%||10.6%||28.1%|
|Darden Restaurants (NYSE: DRI )||22.9%||5.9%||25.2%|
Source: S&P Capital IQ.
Beyond impressive economics, McDonald's has a talented management team that remains committed to executing on the company's powerful business model for years to come. This year, longtime CEO Jim Skinner plans to step down, after having executed masterfully on the company's "Plan to Win" blueprint, which was instituted in 2003, one year before he took the helm -- and Don Thompson, the man taking the reins from Skinner, plans to maintain this vision. In fact, Thompson oversaw two of McDonald's most successful bets over the past several years, including modernizing the restaurants and rolling out its popular McCafe lineup of coffee drinks. Expect this kind of aggressive, forward thinking to continue as Thompson moves into the driver's seat.
Buying from the Value Menu
Trading at slightly over 16 times earnings, McDonald's isn't outrageously cheap, but since I distinctly believe McDonald's is an above-average business, I'm comfortable paying a fair price for its stock. Especially factoring in its current dividend yield of 3.2%, and its streak of raising that payout for 35 years, I'm happy with what I'm getting at today's valuations. Tomorrow I'll buy 142 shares of this classic Buffett stock for my Real Money portfolio. Buying great companies at reasonable valuations certainly worked out well for the Oracle. This one's for you, Warren.
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