But there are initiatives here to be excited about. Steve Easterbrook, who took over CEO duties earlier this year, has announced that the company is going to eliminate unnecessary bureaucracy through restructuring segments, refranchise 3,500 restaurants which will increase their franchised restaurants to 90% of the company total, improve the food, slim the menu, and also offer the ability to build custom burgers in select markets.
It will take time to turn a behemoth like McDonald’s around, but you’re paid a very attractive 3.58% yield to wait in the meanwhile. And you have to like the odds that people will continue to buy their products. The stores are ubiquitous and the food is still highly convenient and provides a great value proposition. I’m certainly enjoying being paid – the stock is in my six-figure dividend growth stock portfolio and has long been a favorite of The 8 Rules of Dividend Investing.
Looking at the valuation, however, the stock appears a bit pricey. McDonald’s sports a price-to-earnings ratio of 21.35. Not only is that high in absolute terms, but it also compares unfavorably to the five-year average of 17.3. I always look for a margin of safety, especially with a company that’s involved in a turnaround story.
But the P/E ratio can only tell us so much. I valued shares using a dividend discount model analysis with a 10% discount rate and a 6% long-term dividend growth rate. That growth rate appears conservative, but the high payout ratio and lack of much growth over the last five years means that’s likely what we’ll see for the foreseeable future, especially with the forecast for EPS growth where it’s at. For perspective, the most recent dividend increase was less than 5%. The dividend discount model analysis gives me a fair value of $90.10.
So the stock doesn’t appear significantly overvalued, but there also isn’t a margin of safety here. As such, I’d be cautious about buying McDonald’s Corporation (NYSE:MCD) right now. Overall, I think there’s a lot to like. Ubiquitous stores across the entire world. A product that’s improving. The company’s aware of their issues and aiming to rectify them. Almost 40 straight years of dividend increases, which will likely continue well into the future. And a yield that’s substantially higher than the broader market.
However, shares appear to lack a margin of safety right now. The current valuation doesn’t seem to price in all the risks and potential for permanent lower growth moving forward. Not the best opportunity in the market, but a minor pullback would make this an interesting long-term pick that provides substantial dividend income that’s also likely to grow in excess of inflation.
Disclosure None
