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Better Buy Now: McDonald's or Shake Shack?

By Andrés Cardenal - Apr 7, 2016 at 1:20PM

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McDonald's offers a sound business and delicious dividends, but Shake Shack has far more succulent upside potential.

In one corner we have McDonald's (MCD 2.14%), an undisputed heavyweight champion in the fast-food business on a global scale. The challenger is Shake Shack (SHAK -2.76%), a dynamic growth player producing explosive performance for investors. Which one is a better purchase right now?

McDonald's for a sound business and reliability
McDonald's has reached a truly gargantuan scale, the company owns over 36,500 stores in 125 countries around the world. It has positioned its restaurants in many of the most coveted locations on the planet, providing it an additional layer of competitive strength -- in addition, that is, to its well-known brand. Scale is a major plus for McDonald's in terms of operational efficiency and negotiating power with suppliers, generating crucial advantages in terms of costs and price competitiveness.

McDonald's refranchised 470 restaurants in 2015, and the company intends to refranchise 4,000 additional restaurants by the end of 2018. This will increase the franchised base from 82% of all stores to nearly 95% of all units in the future. This efficient business model allows McDonald's to generate big and recurrent cash flows, which management translates into consistent dividends and buybacks for investors.

Image source: McDonald's.

McDonald's paid its first dividend in 1976, and it has increased dividends in each and every year since then. The company returned $9.4 billion to investors via dividends and buybacks in 2015, and management is planning to allocate an even bigger $14 billion to cash distributions in 2016. At current prices, McDonald's stock pays a dividend yield of 2.9%, not bad at all coming from such a solid and reliable dividend powerhouse.

Growth tends to naturally slow down as a company gains size over time, and it's not easy for a company as big as McDonald's to find new growth venues. However, it still delivered a solid increase of 5% in global comparable sales in the fourth quarter of 2015, and management is betting on Asia for new growth opportunities. McDonald's has recently announced that it plans to open 1,500 restaurants in China, Hong Kong, and Korea over the next five years.

Shake Shack offers delicious growth
Shake Shack has a market capitalization value of $1.35 billion -- that's only 1% the size of McDonald's and its colossal market cap of $114.6 billion. In addition, Shake Shack is priced for demanding growth expectations, and this makes the stock particularly volatile. For this reason, investors in Shake Shack need to be willing to accept more volatility than those investing in McDonald's.

On the other hand, Shake Shack is firing on all cylinders. The company offers high-quality hamburgers, hot dogs, and shakes made with fresh and natural ingredients, and it's gaining traction among customers. Shake Shack is particularly popular among millennials and young consumers, a crucial demographic group in the fast-food business.

Financial performance doesn't leave much to be desired: Shake Shack announced a mouthwatering increase in revenue of 46.8% during the fourth quarter of 2015, reaching $51 million in sales during the period. Same-store sales grew by a vigorous 11%, and average weekly sales per restaurant reached an impressive $89,000 during the quarter, a material increase from 85,000 in the same quarter during 2014.

Image source: Shake Shack.

Restaurant-level operating margin was at 28.2% of revenue last quarter, an increase of 590 basis points versus the same quarter in the prior year. However, Shake Shack is aggressively investing for growth, so overall company-level earnings are unstable and hard to predict over the middle term. This is another reason why Shake Shack offers far more uncertainty than McDonald's.

Shake Shack still offers enormous room for expansion looking forward. The company has only 45 domestic stores as of the end of 2015, 44 of them company-operated. Management calculates it has enough room for 450 locations in the U.S. alone. In international markets, Shake Shack is barely getting started, as the company has only 35 locations. As long as management continues playing its cards well, everything indicates that Shake Shack is poised for succulent growth in the years ahead.  

And the winner is...
If you are looking for a sound business, predictable returns, and consistent dividend payments, then McDonald's is the better choice. The fast-food giant is clearly more stable and reliable than Shake Shack, and low-risk investors should probably stick with Ronald McDonald. On the other hand, size is a major limitation when it comes to growth, and McDonald's just can't be expected to deliver the kind of performance Shake Shack is producing.

Shake Shack has a more innovative proposition for customers, the company still offers enormous room for expansion over the long term, and management is doing a great job at capitalizing on its opportunities and rewarding investors with impressive performance. Chances are that Shake Shack stock will deliver higher returns than McDonald's over the coming years, so investors who are willing to tolerate higher volatility in exchange for superior upside potential ought to go with Shake Shack.

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Stocks Mentioned

McDonald's Corporation Stock Quote
McDonald's Corporation
$233.91 (2.14%) $4.91
Shake Shack Inc. Stock Quote
Shake Shack Inc.
$41.98 (-2.76%) $-1.19

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