Please ensure Javascript is enabled for purposes of website accessibility

Better Buy: McDonald's vs. Papa John's

By Jon Quast – Oct 11, 2020 at 2:00PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Sometimes, buying proven reliability is better than betting on potential.

If you could only buy one stock, would you buy a dependable Dividend Aristocrat with limited upside, or would you rather bet on a turnaround play with a much lower dividend yield?

If you just got lost in this investing jargon, don't worry -- we'll define some terms in a moment. But that's the question investors should ask when deciding between investing in fast-food giant McDonald's (MCD -1.56%) versus pizza chain Papa John's International (PZZA -2.41%).

The turnaround underway at Papa John's is real, and that's good news for shareholders. But I'd pick the reliable dividend of McDonald's if forced to choose. 

A hamburger, drunk, french fries, and dipping sauce are featured against a red background.

Image source: Getty Images.

A dependable restaurant stock

McDonald's the restaurant needs no introduction, but perhaps McDonald's the company does. The coronavirus has distorted current financials, but if we turn back the clock to 2019, we get a clearer picture of the business. Of the nearly 40,000 locations around the world, 93% are owned by franchisees. The 7% operated by the company generated 45% of total revenue. Sales from franchised locations don't go to McDonald's, though the franchisees pay a small ongoing royalty. And franchise royalties made up only 19% of McDonald's top line. Most of the remaining revenue (36%) comes from rent payments. It turns out McDonald's is the landlord for many of its restaurant locations around the world. 

So McDonald's restaurants only make money by selling food, but McDonald's the company makes money by selling food, licensing its brand, and owning real estate. Therefore, this company's income is more diversified than one might otherwise think, resulting in greater dependability. It's so dependable that it's a Dividend Aristocrat.

To become a Dividend Aristocrat, you not only have to pay your dividend for at least 25 consecutive years, you have to raise your dividend every year. McDonald's recently announced it would be raising its quarterly dividend 3% to $1.29 per share, marking the 44th consecutive year of raising the payout. 

I expect business for McDonald's to continue performing well and for the company to keep the dividend streak going. Therefore, I don't think the stock has much downside. But I do question the upside. Overall revenue increases by a relatively small amount when restaurant sales go up, given the diverse income streams. And when you have 40,000 locations, there are only so many more restaurants you can open.

A pizza box is stuffed with money.

Image source: Getty Images.

A compelling turnaround

Papa John's is making a comeback. In 2018, sales were slumping, and the company parted ways with its founder, John Schnatter. New CEO Rob Lynch took over in Aug. 2019, and the company's results have steadily improved since then. Comparable-store sales are a measure of sales at stores open at least a year, and Papa John's global comps have increased for five consecutive quarters. That's a good start.

Papa John's comps in North America were down 10.5% in 2018. When sales decline per location, it hurts profitability, because restaurants lose operating leverage. And that was particularly bad for Papa John's franchisees. In North America, franchisees closed more locations than they opened from 2017 through 2019.

Through some new menu items and an $80 million fund to support advertising and lend financial aid, Papa John's new management is seeing sales rise, resulting in fewer store closures. Shifts in consumer habits from the coronavirus pandemic also helped since pizza travels well for delivery. Comps were up a record 28% in the second quarter of 2020. This growth added three million new customers to Papa John's digital channels, which can be a long-term tailwind.

Earnings per share peaked back in 2017 at $2.83. Even with all the improvements to the business so far, the company only earned $0.65 per share in the first half of 2020. In short, this business still has a long way to go in its recovery. Nevertheless, the stock trades higher now than it did for much of 2017. To me, it seems like much of Papa John's turnaround is already priced in.

The winner

Right now, Papa John's is making good progress toward returning to its former glory. But what's the market-beating opportunity after that? I expect management will lay out its long-term vision once the pandemic is fully over. But for now, I don't see much upside. Sure, investors could buy now and collect the dividend while waiting for the company to discuss a clearer plan, but with just a 1.1% dividend yield, that's probably not the best option for income-hungry investors.

The dividend yield for McDonald's stock is twice that of Papa John's. This, and its reputation as a Dividend Aristocrat, make me comfortable choosing McDonald's today. That said, I think it will perform in line with the market at best, which may not be good enough for all investors.

Jon Quast has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

McDonald's Corporation Stock Quote
McDonald's Corporation
MCD
$230.74 (-1.56%) $-3.66
Papa John's International, Inc. Stock Quote
Papa John's International, Inc.
PZZA
$70.01 (-2.41%) $-1.73

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
326%
 
S&P 500 Returns
102%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 10/02/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.