Is McDonald's Worth the Extra Premium?

Includes: BKC, MCD, YUM
by: Mark Riddix

I have been a McDonald’s (NYSE:MCD) shareholder for some time now. The stock has been a good investment for the past five years. My reasons for owning the stock were plenty. McDonald’s has over 32,000 restaurants around the world and has plans to continue expanding internationally. According to the company website, McDonald’s serves over 60 million customers a day. The company has become a staple in the foodservice retail industry. Let’s take a look at the pros and cons of an investment in McDonald’s.

McDonald’s is the most popular fast food restaurant in the industry. Everyone goes to McDonald’s. Whether it’s the Big Mac, the milkshakes, salads, crispy chicken wraps, ice cream cones or the fries; customers flock to McDonald’s by the millions. Its drive-thrus are often packed as customers drive in to get an early morning McMuffin or a late night snack. McDonald’s is an earnings giant with nearly $24 billion dollars in annual revenue.

The margins are incredible at McDonald’s. McDonald’s has a 20% profit margin, 40% gross margin and an operating margin approaching 30%. That’s better than competitors Yum Brands (NYSE:YUM) and Burger King (BKC). The king of fast food has been able to grow earnings at a remarkable 19% clip per annum. McDonald’s has made efficient use of its assets and capital earning a 15% return on assets and 36% return on equity.

Although McDonald’s has all of these things going for it; the stock is not cheap. The stock currently trades at just under $75 per share. This values the company at 16.5 times earnings. This is not a high multiple based on past growth but is high compared to future forecasts. McDonald’s is projected to grow earnings at a 10% clip over the next few years. That means the stocks trades at 1.6 time projected earnings.

I am not suggesting that investors sell shares at the current price but I would not start a new position at their current valuation either. McDonald’s would be attractive to buy again in the low $60’s. The stock would be a steal in the $50’s. At $75 a share, investors should sit on the sidelines. McDonald’s may be a great franchise but it is not worth the extra premium.

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