It can be difficult to find bargains in a rising market; investors who generally look for stocks trading at a discount to no-growth intrinsic value are forced to pay full price for stocks and bet on growth or sit on the sidelines as the market surges.
For investors who choose to stay invested despite a lack of compelling investment options, it is best to only pay for growth that is reasonably assured without the necessity of a thriving global economy.
McDonald’s Corporation (NYSE:MCD) is one company that offers investors such an opportunity. The company is the clear leader in the fast food industry but still has substantial growth opportunities in Latin America and China.
Not Afraid to Tweak Formula for Success
Over the years, McDonald’s Corporation (NYSE:MCD) has thrived due to its consistent offering, ownership of its real estate, and the strength of its employee training programs.
However, despite thriving due to those three general factors, the company has been unafraid to change some parts of its offering. For example, McDonald’s has recently renovated many of its restaurants and changed its marketing campaigns. In addition, relatively new premium products and specialty coffee have been a big success for the company.
McDonald’s Corporation (NYSE:MCD) continued success allows it to produce billions in free cash flow each year, which it uses to expand into new markets, namely Latin America.
No Switching Costs, but Competition Can’t Compete
Despite having virtually no switching costs, McDonald’s has been able to stay well ahead of its competitors. The Wendy’s Company (NASDAQ:WEN) has been unable to replicate McDonald’s success in introducing premium products to its menu. The company is also hoping that a renovation of its restaurants will meet the same success that McDonald’s renovation has had. However, The Wendy’s Company (NASDAQ:WEN) has never been able to establish the consistency in earnings and free cash flow that makes McDonald’s Corporation (NYSE:MCD) the industry leader.
Jack in the Box Inc. (NASDAQ:JACK) has had more success than The Wendy’s Company (NASDAQ:WEN), but is still far behind McDonald’s in terms of profitability. Its Jack in the Box restaurants have a long runway for growth in the United States, and its Qdoba brand is expanding as well. However, it too is unable to replicate McDonald’s high and steady margins.
There are no durable competitive advantages in the industry. All restaurants — including McDonald’s — are subject to intense price competition. However, McDonald’s Corporation (NYSE:MCD) has shown a unique ability to navigate the competitive landscape in a manner that allows it to earn consistent free cash flow.
Investment Considerations
At 18.1x earnings, investors are paying full price for McDonald’s growth opportunities and superior operations. But if the company can solidify itself as a serious competitor to Starbucks Corporation (NASDAQ:SBUX), continue to fend off rivals in quick-service restaurants, and continue to grow in emerging markets, then shareholders will be rewarded even if they have to pay up for growth.
The company currently trades at 12x last year’s pre-tax income. If the company can grow at 4% per year over the next few years, then the stock today is worth about 15x pre-tax earnings — or $120 per share.
Final Thoughts
Sometimes it is hard to stay on the sidelines, especially in a rising market. McDonald’s Corporation (NYSE:MCD) offers investors reasonable growth at a reasonable price. That’s about the best you can hope for as investors run out of places to put cash to use.
The article Fast Food Restaurant Is Cheaper Than its P/E Indicates originally appeared on Fool.com and is written by Ted Cooper.
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