It’s a new position for me, and I put some of the money I made from Harleysville Group's (NASDAQ:HGIC) buyout towards this position, and may grow it over time with later investments as I do for several of my existing positions (particularly if the price dips).
I’ve been watching MCD for a while, but have had some reservations regarding the ethics of the business and the fact that the stock price is at an all time high. However, I decided I wanted another fairly dependable consumer pick to add to my portfolio to complement my energy, health care, and financial holdings, and I feel that the valuation with a P/E of 18 is reasonable considering how the business works and how it compares to its competitors.
Investing in a company while it’s trading at a historical high for itself is often not comfortable, but I feel that the absolute valuation of the company remains reasonable, and that’s what is important in my view. It’s a matter of expecting good risk-adjusted returns rather than focusing purely on the expected return.
Here’s what put me over the edge in making the decision to invest: Franchising
The franchising aspect of McDonalds is an area that I touched on in my McDonalds analysis, but I feel I could have highlighted it a bit more. What makes franchising appealing from an investor standpoint is the addition of external capital.
Normally, when a business wants to expand, it has to allocate capital towards the expansion, and that is money that can’t go towards dividends or share repurchases. McDonald’s does this as well, but when franchisees invest in owning a McDonalds, they have to put a lot of their own money on the line.
A potential owner of a McDonald’s has to put 25-40% of the total cost up front as a down payment, and then secure their own financing for the rest. This provides a means of growth outside of McDonald’s own capital; investors seek to own a restaurant, McDonald’s trains them, and then allows the best of them to put their money towards an existing or new restaurant, and then takes a portion of the money made from the restaurant in the form of a service fee and rent.
With McDonald’s excellent metrics and unrivaled advertising budget, this is a pretty powerful combination. McDonald’s can consistently secure new streams of income putting a ton of money towards development. The result is that McDonald’s can grow at a decent pace while also maintaining substantial free cash flow to pay shareholders. Its current yield is 3%.