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3 Reasons Why Now Is a Good Time to Buy McDonald's Stock

Motley Fool - Tue Oct 3, 2023

McDonald's (NYSE: MCD) may be an icon of the fast food industry, but it is also an unexpected investment in many ways. While it may not generate the excitement of a fast-growing tech stock, it typically produces increasing stock price appreciation income and usually outperforms the S&P 500.

Still, before opening a position, investors should learn about the business and how it affects the stock price. By understanding three critical facts about the company's stock, prospective shareholders can have a better understanding of the opportunity McDonald's has placed on the menu.

1. McDonald's is not the business you might think it is

Given its nearly 41,000 restaurants and widespread name recognition, one can forgive some investors for seeing McDonald's as a restaurant stock little different from Chipotle or one of the Restaurant Brands International restaurants like Burger King.

However, after looking at the business, one might get a false impression that it is actually a real estate investment trust (REIT) masquerading as a restaurant. McDonald's owns the buildings run by franchisees and collects rent on the property. It also receives a fee amounting to the percentage of items sold and an initial fee when an entrepreneur launches a new franchise.

These activities create a majority of the company's income. Moreover, they tie its success to a relatively stable real estate market, and the rent payments tend to remain a steady source of income. It also means that the ups and downs of the restaurant industry do not affect McDonald's as severely.

2. The restaurant chain's financial position

Consequently, McDonald's grossed more than $12 billion in revenue during the first half of 2023, 62% of which came from its franchises. This means that the 5% of the restaurants it owns comprised the other 38% of revenue.

Nonetheless, those company-owned restaurants accounted for just over half of its expenses, meaning nearly all the $5.6 billion in operating income came from franchises.

After adding interest, non-operating expenses, and taxes, McDonald's earned a GAAPnet income of $4.1 billion in the year's first half, a 78% increase compared with the same period last year.

Investors should also know that an $850 million drop in other operating expenses significantly boosted its profit, meaning that its high earnings growth rate was probably a one-time event. Going forward, analysts forecast non-GAAP net income increases in the high single digits for the current and the upcoming year.

Additionally, its $6.08 per share annual payout offers a dividend yield of 2.3%, significantly above the S&P 500's 1.6% yield. And since the payout has risen yearly since 1976, the rising profit should continue to fund an increasing payout.

3. McDonald's sells at a relative discount

Furthermore, McDonald's has become increasingly appealing from a valuation perspective. If not counting the brief spike downward in early 2020, the price-to-earnings (P/E) ratio of 24 is close to five-year lows for the earnings multiple. That valuation makes it comparable in value to Restaurant Brands International and Yum! Brands.

Such a P/E ratio increases its appeal due to its performance. Its dividend growth and steadily rising profits have also helped McDonald's outperform the S&P 500 and its peers. Such results give investors good reason to pay closer attention to the stock.

MCD Total Return Level Chart

MCD Total Return Level data by YCharts

Making sense of McDonald's

McDonald's has succeeded primarily because of its business strategy. Its real estate and franchise-focused approach has earned it increased revenue and provided stability in what can be a volatile industry.

Consequently, revenue, net income, and dividends have risen as a result. With the relative discount in the P/E ratio, investors focused on the restaurant industry or in need of dividend income might want to consider a position in this stock.

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Will Healy has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chipotle Mexican Grill. The Motley Fool recommends Restaurant Brands International. The Motley Fool has a disclosure policy.

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