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Jerry B. Wade is founder and President of Wade Financial Group, Inc. (WFG) and has been since its inception in 1994. WFG is an independent advisory firm in Minneapolis, Minnesota, which provides comprehensive financial planning, tax planning, investment management and estate planning for high... More
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The Investment Contrarian
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  • McDonald’s: The Not-So-Obvious Inflation Hedge?

    With the backdrop of a complete economic meltdown avoided for now, it appears as though investors have begun to pile into the inflationary camp, as evidenced by the recent rally in gold, 52% above its 52 low low, as of 12/4/09.  Yet much of the investment world continues to debate whether or not the economy is in for a prolonged period of inflation or deflation. 

    Investors need not take sides to make handsome returns in the coming decade.  My Paid-To-WaitTM investment strategy embraces corporations with the following attributes:

    1.     competitive advantages

    2.     healthy balance sheets

    3.     and above average (but more importantly, growing) dividend yields

    Companies that possess the above attractive characteristics should reward shareholders in either inflationary or deflationary periods. 

    McDonald’s Is One Such Holding

    Excuse the pun, but as recently as mid-September, McDonald’s (MCD) yield offered a mouthwatering 4%.  The world no longer seems to care about its economic resilience.  As of 12/4/09, (MCD) has underperformed the S&P by 24 percentage points this year.  Instead, the massive rally since March ’09 has been led by low quality companies.

    Many people know that McDonald’s possesses one of the world’s most valuable brands (6th according to Interbrand). (MCD) possesses one of the best inflation hedges around and trades at a healthy discount to the market’s P/E multiple as measured by forward earnings estimates.

    What Makes (MCD) So Attractive AT This Time?


    1.     Franchise Agreements.  In addition to featuring an attractive dividend yield (at 3.6%, 70% more than the market), the real secret lies in the company’s relationships with the franchisees who operate over 80% of the chain’s locations.  More than two thirds of the company’s operating profits arise from an annuity-like stream of rent and royalties based upon franchisee revenue, which is based on dollar volume.

    2.     Land Baron.  By owning 45% of the land and 70% of the buildings it occupies (or securing long-term leases on both), McDonald’s has contractually entitled itself to more than $23 billion of cash flows through future minimum rent payments under its existing franchise agreements alone.  The result is free cash flow that can be used to increase the dividend, repurchase shares, pay down debt, and reinvest in the business to the extent profitable growth opportunities arise.

    3.     International Exposure.  McDonalds has the most globally diversified restaurant operation on the planet relative to its closest competitors, with more than two-thirds of its revenue and over half of its operating profit coming from locations outside the US.  Thus a weaker dollar results in higher reported sales when international revenue is translated back into US dollars, helping investors offset debasement in the US currency.  

    4.     Remaining Inflation Protection.  Unlike many business models, McDonalds also benefits from rapid inventory turnover, ability to adjust menu prices and cost controls, and substantial property holdings (many of which are fixed costs and party financed by debt made less expensive by inflation).


    In addition to serving as an attractive inflation hedge, we demonstrate below why longer-term investors can reasonably expect to earn a double-digit annual return owning McDonald’s, in sharp contrast to the uncertain return from owning gold.  Gold possesses a severe opportunity cost, as gold doesn’t throw off income or grow like stocks while tying up your money.

    We derive our minimum 10% return estimate as a function of (1) dividend and (2) earnings per share growth without counting on any (3) P/E multiple expansion.

    (1) DIVIDEND

    McDonald’s has paid a dividend for 33 consecutive years since 1976.  At $2.20 per share this represents at 3.6% yield.  McDonald’s payout ratio is 52%, leaving room for future growth.  It offers the highest yield of its publicly traded competitors. (MCD) boasts the highest restaurant credit rating (cash flow from operations covered an amazing 59% of its debt load last year).


    Revenue Growth. According to NPD Group, Inc., fast food hamburger restaurant sales should grow 4% over the next five years.  For those who believe (MCD) can continue to capture share, Technomic estimates each 0.1% gain of share in the QSR industry is worth $56.3 million of annual sales.  Substantial growth opportunities remain outside the established major markets.  Within China, for instance, there are more than four times as many people as in the US, yet only two restaurants for every million people (versus 60 in the US).

    Margin Expansion.  Factoring in lower food and packaging raw material costs, the move to refranchise more company-owned restaurants, and lower interest expense, there should be a modest amount of margin expansion resulting in operating profit growth at least 1-2% faster than its 4% revenue growth.  Hence we assume 5-6% operating profit growth, conservative even against management’s own 6-7% estimate. 

    Buybacks.  Factoring in share repurchases of 2% (below actual sharecount reductions of 4% in 2008 and 3% in 2007) on top of its 5-6% operating profit growth would result in EPS growth of 7-8%. 

    (3) VALUATION           

    We are not betting on P/E expansion – if realized, that would certainly be gravy!  But we want to make sure that our 10-12% fundamental economic return (7-8% EPS growth plus 3.6% dividend) is achievable, which means we must not expect multiple expansion (or be hurt by contraction).

    Today’s valuation appears reasonable.  The stock’s P/E of 15.9X trailing earnings is less than the S&P at 16.1X and is the lowest for (MCD) in over a decade.  Its forward earnings yield of 7.2% is well above the S&P yield (6.4%) and the 10-year treasury yield (3.48)%.

    Investing lesson:

    Taking the unpopular view is how to make money.  In fact, a contrarian style of investing is the ONLY method that has proven, over time, to reduce risk and take advantage of mispriced investment opportunities.

    Disclosure: Wade Financial Group, Inc. and the WADEX mutual fund hold a position in McDonald’s (NYSE:MCD).
    Tags: MCD
    Dec 07 11:54 AM | Link | Comment!
  • Forget Buffett, Wilbur Ross Is the Man You Want to Invest With
    While Warren Buffett gets all the press, a number of legendary investors fly under the radar screen, unknown to most individual investors and many professionals as well.
    One such legend, Wilbur Ross, has an incredible track record as a “vulture capitalist”, meaning he buys businesses and investments that are in trouble, turns them around and makes millions each time he performs his magic.
    Until recently, only ultra high net worth investors could participate alongside Mr. Ross, as his company was privately held. INVESCO (NYSE:IVZ) acquired WL Ross & Co. in 2006. INVESCO now offers several ways to potentially benefit from Mr. Ross’s skill. 
    One such investment recently had an IPO as a publically traded REIT, INVESCO Mortgage Capital REIT (NYSE:IVR). It invests in RMBS, CMBS and mortgage loans in conjunction to financing through PPIP and TALF where possible. All of these acronyms are defined at the end of this article.
    (IVR) is managed by an institutional arm of INVESCO.  WL Ross & Co. consults with the management of (IVR).
    (IVR) has fully invested the proceeds received from the IPO and has applied for loans to buy CMBS through the TALF program. It is still exploring opportunities to invest through PIPP.
    (IVR) was launched on 6/26/2009 at an IPO price of $20. As of 8/29/09 it is trading at $20.01. It has mostly traded below its IPO price and volume is averaging 102,000 shares a day.
    While REITs have rallied recently and are now potentially overvalued, buying into IVR is an opportunity to get in on the ground floor vs. a potentially dangerous upper balcony!
    Investors looking for a way to profit from the carnage that has taken place since the U.S. financial markets imploded in the fall of 2008 would be wise to consider an investment in (IVR).
    I recommend starting with a 1% position in (IVR) and then slowly adding to it as the REIT confirms its increased participation in the various U.S. Government sponsored programs.
    Residential Mortgage-Backed Security (NASDAQ:RMBS): A type of security whose cash flows come from residential debt such as mortgages, home-equity loans and subprime mortgages. This is a type of mortgage-backed securities that focuses on residential instead of commercial debt. Holders of an RMBS receive interest and principal payments that come from the holders of the residential debt.
    Commercial Mortgage-Backed Securities (NYSEARCA:CMBS): A type of mortgage-backed security that is secured by the loan on a commercial property. A CMBS can provide liquidity to real estate investors and to commercial lenders. As with other types of MBS, the increased use of CMBS can be attributable to the rapid rise in real estate prices over the years. Because they are not standardized, there are a lot of details associated CMBS that make them difficult to value. However, when compared to a residential mortgage-backed security (RMBS), a CMBS provides a lower degree of prepayment risk because commercial mortgages are most often set for a fixed term.
    Public-Private Investment Program (PPIP): A plan designed to value and remove troubled assets from the balance sheet of troubled financial institutions in the U.S.Essentially, thePublic-Private Investment Program's goal is to create partnerships with private investors to buy toxic assets. The program is designed to increase liquidity in the market and to serve as a price-discovery tool for valuing troubled assets. The Public-Private Investment Program consists mainly of two parts: a Legacy Loans Program and a Legacy Securities Program. The Legacy Loans Program uses FDIC-guaranteed debt along with private equity to purchase troubled loans from banks. On the other hand, the Legacy Securities Program is designed to use funds from the Federal Reserve, Treasury and private investors to reignite the market for legacy securities. Legacy securities include certain mortgage-backed securities, asset-backed securities and other securitized assets that the government deems to be eligible for the program.
    Term Asset-Backed Securities Loan Facility (TALF):  A program created by the U.S. Federal Reserve in November, 2008 to boost consumer spending to help jumpstart the economy. This is accomplished through the issuance of asset-backed securities. The collateral for these securities is made up of student, personal auto and credit card loans. Backing for these loans comes from the (up to) $1 trillion provided by the New York Federal Reserve Bank.  This program is in place until December, 2009. Issuance of asset-backed securities continues only until that point. If, on that date, the government decides that the economic state has not improved up to an appropriate level, benefits of the plan are to be reassessed.
    WL Ross & Co. is acknowledged as one of the world's leading turnaround groups. They invest in and restructure financially distressed companies. Their extensive knowledge, insight and longevity offer a distinct advantage when assessing and cultivating new investment opportunities, particularly in niche markets.
    Mr. Ross’s experience in distressed securities dates back to 1976 when he led the worldwide bankruptcy advisory practice at Rothschild Inc. For over a decade, his team assisted in restructuring more than $200 billion in liabilities in major corporate restructurings and bankruptcies in North America.
    In 2000, Mr. Ross established his own company with $440 million in investor money. WL Ross & Co. joined INVESCO Ltd. in 2006.
    Disclosure: My firm, Wade Financial Group, Inc. is long IVR.
    Tags: IVR, IVZ, IVR
    Aug 25 2:39 PM | Link | Comment!
  • Is Your Life Insurance Company Considered Strong? recently released their analysis of the top life insurance companies in the U.S. based upon financial strength and reserves.  This list is provided below.;

    You will not find any of the companies that sell "gimmick" annuity products on the above list. Reason why: the companies that offer "to good to be true" product features are now faced with the daunting liability of having to make good on their promises, something that will be very hard to accomplish.  This poses a "ticking time bomb" for the heirs of many current annuity holders. Ratings has been recognized as the most conservative grader of life insurance financial strength by a leading consumer publication and was singled out as the only ratings agency that doesn't accept payments from any of the companies it tracks.

    Investing lesson: 

    There is no such thing as a free lunch.  Be wary of investment/annuity pitchmen.

    Aug 19 9:22 PM | Link | Comment!
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