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Better Buy: Chipotle Mexican Grill, Inc. vs. McDonald's

By Dan Caplinger - Mar 23, 2016 at 5:46PM

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Which of these restaurant giants is the smarter pick right now?


Image: Chipotle Mexican Grill.

There's been a revolution in the restaurant industry. For decades, McDonald's (MCD 1.77%) led a host of fast-food chains that gave customers the convenience and speed they craved, and growth in the industry throughout much of the second half of the 20th century centered on developing similar business models to the one that the Golden Arches executed so well. Yet recently, the rise of the fast-casual chain has changed the way people eat, and Chipotle Mexican Grill (CMG 3.06%) has been a leader in the fast-growing space.

With both companies facing major challenges, investors want to know which one is the better buy right now. Let's take a closer look at Chipotle and McDonald's, and compare them on a number of metrics to see which one looks more attractive under current conditions.

Valuation
McDonald's and Chipotle have seen their stock prices go in opposite directions recently. Since March 2015, McDonald's shares have soared almost 30%. Chipotle, on the other hand, has struggled, falling more than 30%.

One common result of such disparate performance is that valuation differences get much wider, often presenting a bargain opportunity for the falling stock. Yet looking at simple valuation metrics, that isn't what we see with Chipotle versus McDonald's. Even after its plunge, Chipotle still trades at 31 times trailing earnings compared to 26 times earnings for McDonald's.

Moreover, McDonald's investors can take even greater comfort from using forward estimates for earnings. On a forward-looking basis, McDonald's sports an earnings multiple of 21 compared to 35 for Chipotle. Chipotle's share-price drop has definitely narrowed what had been a much-wider gap between the two stocks, but McDonald's still looks cheaper on a simple valuation basis.

Dividends
Chipotle and McDonald's also show their differences when it comes to dividends. The younger Chipotle has never paid a dividend, as it has chosen to take much of its available capital for internal investment in growing its business. The fast-casual Mexican food chain has also made repurchases of its stock from time to time, including $460 million in buybacks during 2015.

McDonald's, on the other hand, has a sterling track record of treating dividend investors well. The company currently has a dividend yield of just less than 3%, which puts it well above the average yield among large-cap stocks in the market. More importantly for long-term investors, McDonald's has put together a 40-year track record of raising its dividends on an annual basis, and that puts it in the rarefied air of the elite Dividend Aristocrats.

McDonald's has also used buybacks to return capital to shareholders. Overall, McDonald's gets the nod for those who put highest priority on dividends.

Growth
The key question for Chipotle and McDonald's involves growth prospects. McDonald's has struggled to produce overall growth for years, and the fast-casual revolution that Chipotle and its peers have led is a big reason why. McDonald's 2015 revenue was its lowest since 2010, and although the strong dollar played a role in that decline, the fast-food giant has had to deal with other adverse trends that have hit its bottom line.

McDonald's net income last year fell to levels investors hadn't seen since 2008. More recent upticks in comparable-restaurant sales have some shareholders breathing a sigh of relief, but once the forward push from an expanded all-day breakfast offering starts to slow, McDonald's will have to figure out how to keep up the pace.

Chipotle's growth prospects have historically been much clearer, because the fast-casual chain has ambitiously expanded its restaurant network at a rapid pace. However, the recent foodborne-illness scare has made many investors question Chipotle's ability to sustain that growth, and the short-term fallout from the problem has led to severe declines in customer counts and sales.

Few doubt that, if Chipotle can bounce back from its recent scare, then getting back on track will let it recoup its losses and produce a long period of sustained growth. Yet some other restaurant chains have never recovered from similar episodes, and investors are fearful that even the mighty Chipotle might succumb to the pressure.

In the end, risk tolerance plays a major role in which of these two stocks is a better buy. For conservative investors who rely on dividend income and want stability, McDonald's looks like the stronger pick right now. For those willing to take risk on a rebound story, Chipotle is compelling at valuations that the stock hasn't seen in years.

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Stocks Mentioned

McDonald's Corporation Stock Quote
McDonald's Corporation
MCD
$247.90 (1.77%) $4.32
Chipotle Mexican Grill, Inc. Stock Quote
Chipotle Mexican Grill, Inc.
CMG
$1,329.02 (3.06%) $39.50

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