McDonald’s Breaks $100: Should You Buy?

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One of the better-performing stocks of the year has been McDonald’s (NYSE:MCD), the world’s largest food service company. McDonald’s operates and franchises restaurants all over the world that cater to virtually every demographic. Furthermore, the company owns an incredible amount of real estate — one of its strategies is to buy land that it will then rent to a franchisee, which also has to pay for franchising rights.

This strategy has catapulted McDonald’s valuation to about $100 billion.

With stocks generally weak for the year, investors have become less aggressive in their stock selections, and as a result, McDonald’s has been a beneficiary. The stock is up nearly 4 percent for the year, while the S&P 500 is up less than 1 percent. Furthermore, McDonald’s trades at a lower P/E ratio — 18 — than the S&P 500, which trades with a P/E over 20. Finally, McDonald’s pays a 3.2 percent yield, which isn’t huge, but which dwarfs the S&P’s paltry 1.8 percent yield.

Analysts expect McDonald’s to grow earnings over the next couple of years. While it earned $5.55 per share in 2013, it is expected to earn $5.81 per share in 2014 and $6.31 per share in 2015.

Thus, while McDonald’s isn’t going to make you rich in the near term, it does seem to be a compelling holding, and one that makes sense for those investors looking for retirement portfolio holdings or for steady, growing income. It is, in many ways, like a bond, given its stability and its penchant for returning capital to shareholders. With bonds performing so well this year and interest rates falling, it makes sense to purchase McDonald’s as a lower-interest rate bet.

But while McDonald’s has a lot going for it, there are some concerns. First, while McDonald’s is undoubtedly the leader in the restaurant space, we have to acknowledge the competitive nature of this business. There are restaurants everywhere, and this makes the industry incredibly difficult to navigate. Now, if you had to buy just one stock in this industry, McDonald’s is probably the way to go. However, with so many other industries out there with businesses that share McDonald’s appeal, there is no need to invest in this particular stock unless the valuation becomes unusually compelling. While the valuation is decent relative to that of the S&P 500 and relative to interest rates, I don’t think it is compelling.

Second, while McDonald’s is the leader in the restaurant space, it has some public relations issues. Environmentalist groups don’t like how it cuts down forests in order to graze cattle. Furthermore, McDonald’s food is by no means healthy. This has been a serious issue for the company that has to compete with the likes of Chipotle (NYSE:CMG) and Panera Bread (NSYE:PNRA), which are emphasizing healthy, organic foods. While McDonald’s has made token attempts to turn its image around by selling milk, apples, and salads, nobody who is serious about his or her health is eating at McDonald’s on a regular basis.

Third, McDonald’s doesn’t own a lot of its restaurants — as I said, it franchises out its brand and products. Nevertheless, its business can still be impacted by rising food prices. All agricultural commodities have been rising in price this year, but two in particular — coffee and beef — have soared. We know that beef is a huge part of McDonald’s business. Coffee is too nowadays, as the company leads the way in the “breakfast wars.” These rising prices are either going to go to McDonald’s bottom line or to its franchisees — either way, McDonald’s is at risk.

Given these points, it seems like McDonald’s is a mixed bag. There are certainly things to like about the company and the stock, even at $100 per share. However, there are risks. A good compromise might be to trade the stock: It is rising, and I think the uptrend can continue so long as it is paying a nice dividend and buying back stock in this somewhat risk-averse market environment. If you do decide to buy the stock, consider using a stop order or selling covered calls against it.

Disclosure: Ben Kramer-Miller has no position in McDonald’s or in any of the stocks mentioned in this article.