Believe it or not, shares of fast-food chain McDonald's (MCD -1.39%) are up more than 100% from their pandemic-prompted low and are trading at nearly three times their price from just 10 years ago. It's surprisingly kept pace with the S&P 500 for many years and even outperformed the index when factoring in its dividends. Given the highly competitive, low-margin nature of the restaurant business, this is nothing short of incredible.
It's such a strong performance, in fact, that interested investors may be too intimidated to dive in even after the stock's modest pullback from January's high. The frothy price-to-earnings (P/E) multiple of nearly 23 isn't exactly encouraging them, either.
This is one of those cases, however, where you might want to worry less about a stock's history and valuation, and worry more about the quality of the underlying company.
More than numbers; qualitative questions investors should ask
Don't misread the message. Valuations do matter.
They're not the only thing that matters when evaluating a stock, though. Just as important -- if not more important -- is the quality of the company in question. Has it proven it's built to last? Is the industry it's in a strong one? Does management truly understand what makes the organization tick and how to maximize its strengths while minimizing its weaknesses?
In the case of McDonald's, the answer to all three questions is a resounding "yes!" The company as we know it today has been around for decades; there's a reason it's become the world's biggest restaurant chain during this time. And of course, people will always need to eat and will always need convenience. As for the organization's leadership, McDonald's CEO Chris Kempczinski may have only been at the helm since 2019, but he's led several different consumer-facing, food-related businesses during his career, including heading up McDonald's 14,000 domestic restaurants. Under his leadership, the restaurant chain is far more profitable now than it was prior to the pandemic.
MCD Net Income (TTM) data by YCharts.
Still, given the stock's steep run-up over the course of the past several years and the subsequently rich P/E ratio, is there enough upside left to justify the risk of jumping in now?
Yes, there is. Here's why.
Why McDonald's stock deserves its premium price
Picking stocks isn't necessarily complicated. But there's certainly an art to it -- an art that can only be taught by experience over time.
That's not to dismiss the numbers-based, scientific side of selecting stocks. Valuations are an obvious way of figuring out how much you're paying for a dollar's worth of earnings. They can help you compare similar (or dissimilar) stocks. Growth rates at least loosely suggest the sort of profits that will be in the cards in the future. You get the idea.
Mere numbers alone don't tell the whole story. Even without consciously knowing it, the market factors a company's qualitative attributes into its stock's price.
Re-enter McDonald's. Its stock is unusually expensive by broad market standards. But the market's pricing in a handful of details that don't show up on a balance sheet or its income statement.
The sheer power of the brand is chief among these details. The golden arches aren't just a logo. They invoke feelings of familiarity and comfort. They also stir hunger. The restaurant chain's choice of red and gold as its flagship colors is no coincidence either. These hues specifically invoke a feeling of happiness and at the same time accelerate heart rates. Of course, the restaurant chain has lifestyle-branded itself so aggressively for so long that many consumers now subconsciously connect these dots with just a passing exposure to the company's name, logo, or jingle.
Another detail justifying McDonald's stock's premium price is its sheer size. With more than 41,000 locales, the company is the world's biggest restaurant chain.
This in and of itself doesn't seem like a huge upside. Sure, it's bigger, but this size also makes it more complicated and costly to manage.
The company's turned its size into a competitive advantage though. In many ways, its footprint prevents rivals from setting up shop in prime locations, since McDonald's is already there.
Finally, what's not readily reflected in the restaurant chain's results is the nature of the business model. The parent company doesn't actually operate most McDonald's restaurants. Around 95% of the planet's McDonald's are run by franchisees. The parent company does own the buildings and property those franchisees operate from, however, and charges them ever-rising, market-based rent for the right to operate their business from that real estate. Although it's a growing point of contention among franchisees, for investors, this relationship supports a steady flow of dividend-driving cash flow.
These are qualities and characteristics no other restaurant chain exhibits. Moreover, these are qualities and characteristics that support the stock's premium valuation.
Be willing to pay up for quality
This isn't necessarily how every investor likes to pick stocks, especially newer investors. Many tend to like numbers and relative comparisons. And quantitative metrics certainly have their place. If nothing else, they help investors determine what likely lies ahead for a particular stock or indicate how the market might feel about a particular company in the future.
There's a seemingly arbitrary, qualitative side of stock-picking too, however, that relies on instinct and intuition. There has to be. Otherwise, all investors would buy and sell the same stocks at the same time.
More important to the matter at hand, McDonald's non-numerical attributes -- like its market position and its business model -- make it a stock worth owning under almost any circumstances. You should be willing to pay a premium for the quality it brings to the table.
So, no, it's not too late to buy McDonald's stock. If anything, the 11% pullback from January's peak is a buying opportunity. This selling suggests worry about waning demand from cash-strapped consumers. But this is just another cyclical headwind that will ease sooner or later, and likely sooner than later.
