Is McDonald’s Stock a Buy?

As the original fast-food franchise business and perhaps the most successful restaurant chain in history, McDonald’s (NYSE:MCD) has been a staple in investment portfolios for decades. In the 1990s, the stock even found its way into the holdings of Warren Buffett’s Berkshire Hathaway investment company.

 

Having sold off by more than 7 percent YTD, McDonald’s is now attracting a second look from investors. So is McDonald’s stock a buy?

McDonald’s reported excellent revenue growth in 2021, with total global revenues advancing to $23.2 billion. This was 21 percent higher than revenue in 2019, representing a strong recovery from the effects of the COVID-19 pandemic. Profits also increased to $7.5 billion, up 59 percent from the previous year.

 

By the end of the year, however, rising costs were beginning to wear on McDonald’s growth. Q4 earnings hit $2.23 per share, compared with analyst expectations of $2.34.

 

Quarterly revenues were also down slightly against expectations, missing the $6.03 billion estimate with a reported revenue of $6.01 billion. While each of these misses was relatively narrow, they did point to the mounting pressure that higher prices were exerting on the company’s performance.

Free cash flow has also been trending higher for McDonald’s recently. The company generated FCF of $7.21 billion in 2021, up nearly 55 percent from 2020. This was also up sharply from 2019’s FCF of $5.88 billion.

 

This steady upward trend in free cash flow is one of the most positive aspects of McDonald’s stock, particularly in light of rising labor and material prices.

 

McDonald’s is also poised for strong future growth. For the first time in years, the company plans to increase its number of US stores this year. This expansion, combined with a renewed focus on its core menu items after several years of attempting to broaden its offering unsuccessfully, should help the company sustain its newfound growth.

 

While growth may slow from its current highs due to rising inflation and a return to normal after the pandemic, McDonald’s is in a good position.

Another potentially attractive aspect of McDonald’s stock is its stable dividend.

 

McDonald’s currently yields 2.21 percent for an annual dividend payout of $5.52 per share. The dividend has grown steadily over the past several years, and McDonald’s is classified as one of the S&P 500’s dividend aristocrats.

 

In 2021, McDonald’s ratio of payouts to diluted EPS was 56.6 percent. This demonstrates that the company is allocating a decent amount of capital to its investors while also keeping more than enough on hand to continue growing sustainably.

 

Over the next 12 months, analyst price forecasts suggest that McDonald’s has a modest upside to offer investors. The median target price is $280, up by 11.3 percent from the current price of $251.65.

 

On the plus side, even the most negative forecast puts the stock at $250, down only 0.6 percent. This suggests that while McDonald’s may not be a massive winner this year, the risk associated with the stock is also reasonably low.

 

The biggest likely drawback for McDonald’s has to do with its valuation. Price to cash flow is especially high at 21.37, compared with an industry average of 11.83. The stock’s P/E is also somewhat high, clocking in at 25.71 against an average of 21.25. These ratios have been improved by this year’s selloff, but are still high enough to warrant scrutiny.

 

McDonald’s could also begin encountering headwinds if inflation continues to run at multi-decade highs. Rising prices have already begun to reduce overall traffic at many fast-food restaurants. While McDonald’s has ridden out inflation thus far, it’s worth taking into account when considering a restaurant chain widely favored for its inexpensive menu options.

 

McDonald’s also faces the ongoing problem of staffing its restaurants in a tight labor market. Rising labor costs have already impacted the company, and many outlets are now open fewer hours due to staffing issues. As with inflation, labor shortages could turn into real problems for the company if they persist or deepen.

 

Finally, McDonald’s also has substantial exposure to the Russian market that could negatively impact its business this year. There are currently 850 McDonald’s outlets in Russia, and the company has reported 9 percent revenue exposure between the Russian and Ukrainian markets. McDonald’s is among the S&P 500 companies with the broadest presence in Russia, making it disproportionately susceptible to current geopolitical tensions.

 

As you can see, McDonald’s stock is a bit of a mixed bag at the moment. An excellent recovery from the pandemic, a very stable dividend history and good long-term growth prospects all point to McDonald’s being a good buy at the moment. This is especially true in light of McDonald’s ability to continue investing into its business while also raising dividends in the future.

 

On the downside, rising costs are clearly beginning to weigh on the company. Q4’s misses on revenue and earnings present moderate cause for concern, even though full-year performance was quite good. Staffing shortages and a disruption of its considerable Russian business could also make 2022 a somewhat rocky year for the company. Most of these headwinds, however, are likely to be transient.

 

From a value perspective, there’s a bit more to McDonald’s than meets the eye. Despite appearing overvalued, the stock is trading at ratios that are comparable to its 5-year average. As a result, McDonald’s stock may not be terribly overvalued, provided it can maintain its current growth trajectory.

 

It’s also worth noting that McDonald’s has seen great success with its customer loyalty program, MyMcDonald’s, which could blunt some of the effects of higher prices. This program, which boasts over 30 million members, has helped McDonald’s engage more effectively with its customer base through promotions and rewards. Going forward, MyMcDonald’s should help the company obtain a competitive edge over fast food restaurants that are not leveraging loyalty programs.

 

In the end, McDonald’s is likely a good buy for moderately conservative investors looking for stocks to hold for the long run. The stock is unlikely to produce stellar returns this year, but the combination of stable growth and a safe dividend makes the company attractive for certain types of portfolios.

 

Although McDonald’s won’t deliver the near-term results of a high-growth startup, it is an extremely strong business that should continue to grow at a sustainable rate.

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