Despite its recent pullback, the S&P 500 is still up 5% year to date (as of this writing). But not all businesses have continued to rally alongside the broad market.
McDonald's (MCD +0.31%), arguably the most well-known restaurant chain on the face of the planet, is one such laggard. Its shares have dipped 8% since they hit a fresh all-time high in January, leaving them down 7% year to date.
Perhaps investors hungry for satisfying returns have their eyes on McDonald's right now. Should you buy this top fast food stock while its price sits below $280?
Lucrative business model
After learning about McDonald's massive operation, it's hard not to be impressed. There are over 40,000 stores scattered across the globe, but McDonald's only owns 5% of them. The rest are run by franchisees.
This franchise model is incredibly lucrative. Outside investors are the ones who front the capital and take on the financial risk of running a store, while McDonald's reaps the rewards in the form of recurring fee revenue. It's an asset-light way to scale up the business. This setup has resulted in strong profitability: In the past 10 years, McDonald's operating margin has averaged a superb 38%.
McDonald's restaurants are supported by its powerful brand recognition, a key asset that has been built up over the decades with effective marketing. The company prides itself on providing customers with consistency and value. A strong brand allows McDonald's to occasionally raise its menu prices as well.
Another positive attribute of this business is the durable demand it sees, regardless of which part of the economic cycle we're in. After declining slightly in 2009 during the Great Recession, for example, sales quickly recovered and reached a new high by the next year.
NYSE: MCD
Key Data Points
Capital allocation policy
McDonald's is a mature enterprise with a proven business model, and it generates consistent profitability as a result. Shareholders benefit thanks to a favorable capital allocation policy.
In December, McDonald's announced a quarterly dividend of $1.67. This marked the 47th straight year the payout has increased, an unbelievable track record that places this company in an elite club. For 2023, McDonald's reported diluted earnings per share of $11.56, so there's still plenty of room for future payout growth.
Income-seeking investors who are risk averse can do a lot worse than buy this stock. The dividend yield of 2.5% is substantially higher than the S&P 500 average of 1.4%, and its long track record of dividend increases is compelling.
Keep expectations low
But if you're like me, you want to identify stocks that have the potential to outperform the broad market over the long term. McDonald's doesn't pass this test, in my opinion.
This is a very mature business. McDonald's has been around since 1955, and it has largely penetrated its markets around the world. To be fair, management has plans to get to 50,000 stores globally by 2027, and executives are really focused on driving greater adoption of the loyalty program. But these strategies are unlikely to result in huge sales gains.
This means there are muted growth prospects. In the past five years, revenue has increased at a compound annual rate of just 3.7%. Looking ahead, it's reasonable to expect a similar pace.
Including dividends, McDonald's shares have returned 59% in the past five years. This seriously lags the S&P 500's total return of 88%. With the price-to-earnings ratio at almost 24 right now -- a premium to the broad market -- you should avoid McDonald's if you want a market-beating stock.
