McDonald's Is Conspicuously Cheap

McDonald's (NYSE: MCD  ) trades at the same price today as it did last March -- a time when the S&P 500 index was much lower. With interest rates at record lows and investors searching for yield, it is anyone's guess why McDonald's trades at a relative discount to Yum! Brands (NYSE: YUM  ) and DineEquity (NYSE: DIN  ) .

McDonald's is cheaper than Yum! Brands and DineEquity
As the second-largest restaurant chain in the world (behind only Subway), McDonald's has the most defensible competitive position in the quick-service industry. Despite its entrenched competitive position, McDonald's trades at a discount to its peers.

Although Yum! has an incredible growth opportunity in China, its KFC division in the country has struggled due to supply chain contamination and a bird flu outbreak. Even though the company's earnings are suppressed this year due to a poor performance in China, Yum!'s stock still trades at 23 times its decade-high earnings per share achieved last year. It also trades at a much lower dividend yield than McDonald's. For a company whose growth has stalled, it trades at a much higher multiple relative to the industry leader than is warranted.

DineEquity, on the other hand, does not have significant growth prospects -- certainly not any better prospects than McDonald's. The company is completing the conversion of its company-owned restaurants into franchised locations -- a move that will boost return on invested capital and give the company a temporary cash windfall, but it will also lower earnings per share. Applebee's is experiencing declining same-store sales and IHOP is growing at a low single-digit rate, which is not much higher than McDonald's 0.9% same-store-sales increase in the third quarter. So, while DineEquity can return more capital to shareholders now that it has sold its restaurants to franchisees, it does not deserve a higher multiple than McDonald's.

These arches are still golden
When it comes to long-term investing, it is the big things that matter most. McDonald's may introduce a new beverage menu that boosts sales one year or screw up a value menu roll-out that depresses sales in another period. But what really matters is that the company has a durable competitive advantage that allows it to reinvest its cash at a high rate and distribute a large amount of earnings to shareholders.

McDonald's has achieved out-sized returns on invested capital for many decades. The exact number varies depending on the calculation, but all methods are in agreement that the world's largest burger chain earns an enviable return for each dollar it invests in its operations. This is possible due to its unparalleled scale -- which allows it to spread out fixed costs across a greater number of locations -- and its tremendous brand equity -- which attracts millions of customers and highly qualified franchisees alike.

MCD Return on Invested Capital (TTM) Chart

McDonald's return on invested capital (trailing-12 months) data by YCharts

McDonald's pays out more than half of its earnings in a dividend each year -- a testament to the advantages of having a huge base of successful franchisees. More than 80% of McDonald's locations are owned and operated by a franchisee, and the company continues to expand using the capital-light franchise model. As a result, McDonald's should be able to keep raising its dividend as it has each of the last 36 years.

MCD Dividend Yield (TTM) Chart

McDonald's dividend yield (trailing-12 months) data by YCharts        


And speaking of the dividend, McDonald's has traded at a higher dividend yield only once in the last 25 years -- and that was during the worst recession since the great depression. Maybe it is time the market reevaluates the stock.

These dividend stocks are even better than McDonald's
Dividend stocks can make you rich. It's as simple as that. While they don't garner the notoriety of high-flying growth stocks, they're also less likely to crash and burn. And over the long term, the compounding effect of the quarterly payouts, as well as their growth, adds up faster than most investors imagine. With this in mind, our analysts sat down to identify the absolute best of the best when it comes to rock-solid dividend stocks, drawing up a list in this free report of nine that fit the bill. To discover the identities of these companies before the rest of the market catches on, you can download this valuable free report by simply clicking here now.



Read/Post Comments (0) | Recommend This Article (0)

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.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2746447, ~/Articles/ArticleHandler.aspx, 12/22/2014 11:34:45 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement