Real Money Stock Pick: An Amazing Company at a Fair Price

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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.

The sun never sets on the Golden Arches
Today I'm buying shares of fast-food powerhouse McDonald's (NYSE: MCD  ) as the next great addition to my value-oriented portfolio.

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.

Company Name

Gross Margin (TTM)

Net Income Margin (TTM)

Return on Equity (TTM)

McDonald's 39.6% 20.3% 38.2%
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.

McDonald's excellence is without dispute, but it's not the only Dow stock whose dividend the Fool loves. In fact, the Fool recently issued a research report detailing three other Dow dividend dynamos that have strong track records of rewarding shareholders. Grab your free copy today.

Andrew Tonner held no financial position in any of the companies mentioned in this article. You can follow Andrew and all his writing on Twitter at @AndrewTonner.

The Motley Fool owns shares of Darden Restaurants and Starbucks. Motley Fool newsletter services have recommended buying shares of McDonald's and Starbucks and writing covered calls on Starbucks. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (2) | Recommend This Article (6)

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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 June 26, 2012, at 12:06 PM, StopPrintinMoney wrote:

    McD is a good stock. In technical terms, it has both support and resistance in the 90's range.

  • Report this Comment On June 28, 2012, at 4:09 PM, TMFDarwood11 wrote:

    McDonald's is one of those companies that has grown, evolved and learned by its mistakes.

    My spouse, who at one time could not understand why I owned the stock, loves the fresh fruit, etc.

    But it wasn't an easy road, There was a time when McD made and attempted to sell, what I call the "anti salad." It was in a small, upright container which seemed a reject from a sugary delight. I hated it and that prompted me to sell what stock I had in the company.

    When the company ditched it, and began making real salads, I realized that "they got it" and knew that it was a time for change, not only for them, but for me. So, a company which I had once owned, and subsequently sold, because it seemed to be in love with diglycerides, became again a "must buy" for me.

    I'm happy with the result.

    When AAPL undergoes its own "ahhh" moment, who knows, I may then purchase their stock. But not yet. Even the remake of "star trek" with the applesque bridge isn't enough. Investing isn't a hobby. It's an opportunity to make a difference and make some money.

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