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Better Buy: IBM vs. McDonald's

By Leo Sun – Sep 29, 2020 at 10:50AM

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Which iconic brand is a better overall investment?

IBM (IBM -2.32%) and McDonald's (MCD -1.56%) are both iconic American brands and members of the Dow and S&P 500. Both companies also frequently attract conservative income investors.

But over the past five years, McDonald's stock has generated a total return of over 150% as IBM eked out an anemic total return of just 1%. Let's see why the golden arches outperformed Big Blue by such a wide margin, and if that trend will continue over the next year.

A woman eats a burger while working on her laptop and phone

Image source: Getty Images.

The similarities between IBM and McDonald's

IBM and McDonald's face three similar challenges.

First, both companies are trying to generate fresh growth with new initiatives. IBM is trying to offset the slower growth of its IT services, business software, and hardware businesses by expanding its higher-growth cloud services. McDonald's is trying to win back diners with healthier and regional menu items, using fresh instead of frozen beef, offering an all-day breakfast, and upgrading its stores with digital kiosks and online orders, though some of those plans have been disrupted by the pandemic, which forced restaurants to find new ways to serve diners.

Second, both companies are struggling with pandemic-related headwinds. IBM's IT services, business software, and global financing businesses all stalled out during the crisis and offset the growth of its cloud services and mainframe sales. McDonald's comparable-store sales plunged as it closed restaurants and curtailed operations in the early days of the pandemic. Many of its locations have since reopened with limited menus (which eliminated all-day breakfast in the U.S.), drive-thru, and delivery options, but those efforts haven't offset its loss of dine-in customers.

Lastly, both companies just brought on new leaders. IBM's cloud chief, Arvind Krishna, succeeded Ginni Rometty as CEO this April. McDonald's promoted Chris Kempczinski, the head of McDonald's USA, as its new CEO last November after firing his predecessor, Steve Easterbrook. Both new leaders have little room for rookie mistakes as their companies face unprecedented challenges.

Which company is growing faster?

IBM's revenue fell 3% to $77.1 billion (but stayed nearly flat after excluding divested businesses and currency headwinds) last year. Its total cloud revenue rose 11% (or 14% on an adjusted basis) to $21.2 billion, thanks in part to its takeover of Red Hat last year, but that growth was offset by the sluggishness of its older businesses. Its adjusted EPS fell 7%.

A man and a woman stand near each other. He is holding a laptop. She is touching a giant touchscreen showing cloud computing icons.

Image source: Getty Images.

In the first half of 2020, IBM's revenue fell 4% year-over-year to $35.7 billion. Its cloud revenue growth accelerated between its first and second quarters, fueled by its focus on the hybrid cloud market,but the COVID-19 crisis exacerbated the declines in its legacy businesses and increased its overall expenses, causing its adjusted EPS to tumble 26%.

IBM didn't provide any guidance for the full year, but analysts expect its revenue and earnings to decline 4% and 14%, respectively. But in 2021, they expect its revenue and earnings to rise 2% and 10%, respectively, as the pandemic passes and it generates fresh growth with new hybrid cloud wins. Such growth would indicate IBM's multiyear streak of revenue and earnings declines could finally be over -- and signal the start of a turnaround.

McDonald's global comps grew 5.9% last year, marking its strongest annual comps growth in over a decade. Its total revenue stayed flat (but rose 3% in constant currency terms) to $21.1 billion, and its earnings improved 5%.

But in the first quarter of 2020, its global comps fell 3.4% year-over-year as the pandemic started shutting down its restaurants. In the second quarter, its global comps plunged 23.9% as the crisis deepened. Its total revenue in the first half of the year fell 19% year-over-year (17% in constant currency terms), and its earnings plummeted 43%.

McDonald's also withdrew its guidance for the full year, but analysts expect its revenue and earnings to decline 10% and 26%, respectively. But for 2021, they expect McDonald's revenue and earnings to rise 14% and 40%, respectively, as the pandemic passes.

The dividends and valuations

IBM and McDonald's are both Dividend Aristocrats of the S&P 500 that have raised their dividends annually for at least 25 straight years. IBM currently pays a forward dividend yield of 5.5%, while McDonald's pays a yield of 2.3%.

IBM currently trades at 10 times forward earnings, while McDonald's has a much higher forward P/E ratio of 27. Those valuations indicate investors are more optimistic about McDonald's ability to rebound after the pandemic than IBM's ability to expand its cloud business while offsetting the slowdown of its older businesses.

The winner: IBM

IBM performed poorly in the past, but its takeover of Red Hat and the expansion of its hybrid cloud services under a new CEO could stabilize its business. IBM still faces challenges in the public cloud market from Amazon and Microsoft, but it remains a top player in the hybrid cloud, which tethers those services to private clouds. As that transition happens, IBM's low valuation and high yield should limit its downside potential.

McDonald's current valuation is pricing in a quick recovery after the pandemic, but a second wave of infections (which is already occurring across several countries) could dash those hopes. IBM could be better insulated from a second wave of infections, since it can still grow its cloud business as brick-and-mortar businesses shut down.

Therefore, I believe IBM should outperform McDonald's over the next few quarters, but the longer term outlook remains uncertain due to the unresolved pandemic headwinds. 

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon and Microsoft and recommends the following options: long January 2021 $85 calls on Microsoft, short January 2021 $115 calls on Microsoft, short January 2022 $1940 calls on Amazon, and long January 2022 $1920 calls on Amazon. The Motley Fool has a disclosure policy.

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Stocks Mentioned

International Business Machines Corporation Stock Quote
International Business Machines Corporation
IBM
$118.81 (-2.32%) $-2.82
McDonald's Corporation Stock Quote
McDonald's Corporation
MCD
$230.74 (-1.56%) $-3.66

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