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What Would You Pay For This Company: The Golden Arches

July 02, 2014 | About:

I love McDonald’s. I really love the Big Mac, the new Clubhouse burger, the fries, branding, everything. I even have it in my portfolio, and cried at the end of Super Size Me because I could only order large fries now. But what is McDonald’s value? And what should you pay for the value it may add to your portfolio? Let’s take a closer look at MCD.

MCD franchises and operates fast food restaurants. One third of its business is derived from the collection of royalty fees from its franchisees, so ensuring that they have prime locations for their restaurants is important. MCD also has to make sure that the products it is developing would be received well by its customers. Another major facet of MCD’s business generation is through marketing. MCD is one of the best marketers ever. They partner with almost every major sporting event, create catchy jingles andThey have created one of the strongest brands through TV advertisements, co-branding with Coca Cola, and by focusing on reaching families with small children. I’m sure you can remember the first Happy Meal you had.

Since MCD is in the food industry, it has virtually an unlimited amount of competition. Everything from other fast food restaurants, supermarkets, diners, online ordering systems compete with MCD. Since there are so many alternatives to what MCD offers, it is amazing to see how well MCD is doing.

McDonald's Logo

Looking at MCD’s quarterly report, we see that there is a 1% increase in company operated restaurants and a 2.2% increase in royalty fees, resulting in a 1.4% increase in revenue from last year. Operating expenses have also increased by 2.2% resulting in a .6% decrease in operating income. Net income was down 5.4% resulting in a decrease of diluted EPS to $1.21, a 4.1% decrease. However, MCD raised it’s dividend to $.81 a share, a 4.9% increase, largely due to it’s share repurchase program.

Now, I like earnings as much as the next guy, but what I love is cash, and this dividend increase is a really sweet incentive to gobble up more shares. But first, lets take a look at the cashflows of MCD and some equations to get at the value of MCD. Cash flow from operations increased by a whopping 11.5%. Cash flow from investing decreased by 13.7 percent, and cash flow from in financing activities increased by 15.7%. Overall, cash increased by 31.8% from last year!

These are some really good numbers for MCD. Although net income and earnings per share were down from last year, cash has increased substantially and the dividend has also increased comfortably. With a projected dividend yield of 3.21%, MCD would be a great addition to a portfolio looking for solid and increasing dividends. What matters now is the price we pay for MCD.

MCD is about 25 times the average market cap of a company in its industry and has about 13.7 times the average income of a company in its industry.

MCD Industry
P/E 18.3 29.4
P/B 6.2 7.3
P/CF 13.8 5.5
Div.Yied 3.2 1.9

I usually don’t like to pay six times the book value for a company, but I added this business because I think it has a very stable dividend, has a great brand that people all over the world recognize and can continue to dominate its market. A personal preference of mine is to buy dividend paying companies that have a P/CF ratio of 15 or less. My investment strategy is to regularly add to the positions in my portfolio each month, so that even though I may be overpaying for a company now, I may be getting it at a discount later on. This is a really long term outlook for me, about 20-30 years or so. However, MCD is a little overvalued at its current price, so let’s try to find a more appropriate price for MCD.

Businesses should be valued at the present value of its future cash flows. MCD’s future cash flows are its increasing dividend. I’d rather use a company’s dividends rather than earnings because the dividends are an actual stream of income being given to the investor. Using Guru Focus’ DCF calculator and inserting dividends per share rather than eps, we get a price of $68.97 without the tangible book value of MCD and $82.36 with the tangible book value. We can average out to get the fair value of $75.66. This is about a 25% decrease from MCD current price. This could very well mean I overpaid for MCD, but I can live with that. What's more important is the price you pay for MCD.

So, what would you pay? 100? 110? 75.66? Whatever the amount, make sure you just don’t overpay.

Disclosure: I am Long MCD

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