McDonald's (MCD 0.47%) checks many of the boxes that investors look for in an ideal stock. It maintains a dominant grip on the fast-food industry, for one, and has been posting market-beating sales growth for over a year. The chain is also highly profitable, and income investors love the fact that Mickey D's makes aggressive use of direct cash returns through dividends and stock buybacks.
Below, we'll take a closer look at that bullish thesis before considering the best reasons an investor might want to pass on buying this stock today.
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The case for McDonald's
Mickey D's stellar growth record is a core reason to buy this stock. In fact, 2017 marked its best annual operating performance since 2012, as comparable restaurant sales jumped 5.3%.
Rivals couldn't come close to that result. Starbucks and Yum Brands have been posting comp sales growth closer to 2%, while Shake Shack reported a comp decline for the year.
McDonald's also stood out from these competitors by returning to robust customer traffic growth last year. That metric has improved for five consecutive quarters, while industry peers are struggling with flat or declining traffic.
At the same time, the chain is becoming far more profitable thanks to a refranchising initiative that's pushed the percentage of company-owned locations down to 8% from 19% at the end of 2015. This strategy lowers reported revenue but raises margins, and the result has been dramatic. Operating margin leapt to 39% of sales last year from 33% in 2016.
McDonald's Operating Margin, data by YCharts. TTM = trailing 12 months.
A bullish investor today could reasonably expect continued growth on the top and bottom lines to support more market-beating share price gains, supplemented by a meaty dividend yield and aggressive stock buybacks.
The case against McDonald's
However, investors might want to rein in their expectations for growth. Years of overbuilding in the industry have made it difficult for even the best-performing businesses to stand out from the crowd. Those trends might already be starting to catch up to McDonald's, as its customer traffic growth slipped back into negative territory in the U.S. segment during the first quarter.
Another caution sign is the company's aggressive spending plans. The chain is on pace to spend $2.4 billion in 2018 (up from $2 billion in 2017) to help franchisees remodel and improve their restaurants, including by better integrating digital ordering. Yes, it's a competitive advantage to have that much cash to direct toward the business. But the spending will dampen stock buybacks in 2018, and could remain a headwind to cash returns going forward.
Finally, McDonald's could lose some of its dominance as consumers shift their spending toward home delivery over the next few years. Its main appeal with many diners, after all, is its value. And that will be difficult to maintain at current profitability levels after adding home delivery services that push costs higher.
In any case, it's likely to be a challenge for CEO Steve Easterbrook and his executive team to maintain McDonald's competitive position as the industry ground rules shift toward digital ordering and delivery.
Why it's still a buy
In my view, these potential risks aren't enough to outweigh the concrete benefits to owning this stock today. McDonald's has demonstrated over the last two years that it can respond to shifting consumer tastes while maintaining, and even boosting, its profitability, earnings, and direct shareholder returns. That flexibility should serve investors well as the company navigates through whatever industry challenges come up next.
