Every time I drive through a McDonald’s (MCD, Financial) and buy value meals for my kids, I always wonder how McDonald’s could make money off the 99-cent burgers. Inflation or deflation, fat year or lean year, food crisis or abundance, high minimum wage or low, McDonalds has kept the price of the burger the same for as many years as I can remember.
Well, maybe they don’t make money off the 99-Cent burgers. Instead, the 99-Cent burgers are their symbols for value to attract customers. Once the customers are in the store or in the drive-thru line, they are bound to buy things other than 99-Cent burgers. They make money off those menu items, such as big Mac’s, hash browns, and soft drinks, and all the other more expensive items.
As a matter of fact, according to the data available in Gurufocus the gross margin for the fast food chain was 24.3% ten years ago in 1998, then it shrank to 13.7% in 2002, but has made a major comeback in recent years. In 2007, it was back to 24.3% again, and as of September 30, 2008, McDonald’s gross margin was at 28.4%, a high for the past ten years.
Gross margin is all important in determining whether a company worth the investment money. Take McDonald’s again, for example: when its gross margin was down to 13.7% at the beginning of the century, its stock price declined from $48 per share in October 1999 to $ 13 in early 2003, much worse than the general market. This time around, however, things are much different; despite the carnage of the general market, McDonald’s was up about 2% for the year 2008 whereas S&P declined 38.5%.
Companies like McDonald’s possess what Warren Buffett calls “economic moat”, a term he used often to describe competitive advantage. In his 1986 Chairman’s Letter to Shareholders, Buffett discussed the economic moat that Berkshire Hathaway’s subsidiary GEICO had:
"The difference between GEICO’s costs and those of its competitors is a kind of moat that protects a valuable and much-sought-after business castle. No one understands this moat-around-the-castle concept better than Bill Snyder, Chairman of GEICO. He continually widens the moat by driving down costs still more, thereby defending and strengthening the economic franchise. Between 1985 and 1986, GEICO’s total expense ratio dropped from 24.1% to the 23.5% mentioned earlier and, under Bill’s leadership, the ratio is almost certain to drop further. If it does - and if GEICO maintains its service and underwriting standards - the company’s future will be brilliant indeed."
Then in his 1993 letter, the proud chairman of Berkshire Hathaway (BRK-A) commented on his investment on Coke and Gillette:
"Moreover, both Coke and Gillette have actually increased their worldwide shares of market in recent years. The might of their brand names, the attributes of their products, and the strength of their distribution systems give them an enormous competitive
advantage, setting up a protective moat around their economic castles. The average company, in contrast, does battle daily without any such means of protection. As Peter Lynch says, stocks of companies selling commodity-like products should come with a
warning label: "Competition may prove hazardous to human wealth."
Companies with deep and wide economic moats can maintain their gross margin, increase their market share, and have the resources to expand geographically. Customer worldwide are willing to pay the higher price for their better perceived values compared to those of competitor’s products. Today, there is almost nowhere in the world where you cannot buy a Coke, a Gillette razor, or a McDonald’s big Mac.
Talking about the 99-Cent hamburgers, one is reminded of a fad that has been happening in the retail world: during the last 15 year or so, all of sudden, stores selling everything for a dollar sprouted up on every corner of the American cross-roads. One of these such stores even carries the name “99C Only Stores” (NDN, Financial). It sells everything from A to Z for exactly 99 cents, before tax, that is. Most of the stuff are made in china, usable but of the lowest tolerable quality. NDN started in 1982 and currently is operating 270 stores, mostly in California, Texas, and Arizona. The company has a market cap of $724 million and an annual revenue of $1.2 billion.
The trouble is, with a name like that, the company effectively preempts itself from any price hiking beyond $1. In recent years, China has supplied most of the inexpensive merchandises. Through frugality, cutting corners on quality, and questionable labor practices, China managed to keep the cost in check. However, year in and year out, eventually even the Chinese manufacturers could not contain the rising costs of material and labor with their shrinking margin and they had to pass the costs to downstream distributor. As a result, NDN has experienced a dwindling gross margin. According to Gurufocus, the company’s gross margin declined from 14.3% in 2002 to 2.2% during the fiscal year through March 2008. For the past twelve month through September 30, 2008, the gross margin has been -1%.
Where NDN couldn’t make with margin, it tried to make with volume. Annual revenue per share has increased from $2.36 in 2002 to $17. 68 for the twelve months ended on September 30, 2008, an incredible increase of 650%. Yet, despite of the impressive increase in revenue, NDN’s EPS has decreased from $0.18 in 2002 to a loss of $0.07 during the past twelve months. All that revenue for nothing!
NDN stock reached a high of $36 back in 2003 and has been hovering around $10 per share since early 2005. I personally think that it saw its best days, and I am not alone. Gurufocus Guru Chuck Akre had accumulated a position of 9.39 million shares by the end of 2007 and has been a net seller ever since. As recently as on Dec. 31, 2008, Gurufocus reported that Chuck Akre had sold his position recently down to 7.23 million shares; so far, Chuck Akre has reduced almost a quarter of his holdings in the company.
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Well, maybe they don’t make money off the 99-Cent burgers. Instead, the 99-Cent burgers are their symbols for value to attract customers. Once the customers are in the store or in the drive-thru line, they are bound to buy things other than 99-Cent burgers. They make money off those menu items, such as big Mac’s, hash browns, and soft drinks, and all the other more expensive items.
As a matter of fact, according to the data available in Gurufocus the gross margin for the fast food chain was 24.3% ten years ago in 1998, then it shrank to 13.7% in 2002, but has made a major comeback in recent years. In 2007, it was back to 24.3% again, and as of September 30, 2008, McDonald’s gross margin was at 28.4%, a high for the past ten years.
Gross margin is all important in determining whether a company worth the investment money. Take McDonald’s again, for example: when its gross margin was down to 13.7% at the beginning of the century, its stock price declined from $48 per share in October 1999 to $ 13 in early 2003, much worse than the general market. This time around, however, things are much different; despite the carnage of the general market, McDonald’s was up about 2% for the year 2008 whereas S&P declined 38.5%.
Companies like McDonald’s possess what Warren Buffett calls “economic moat”, a term he used often to describe competitive advantage. In his 1986 Chairman’s Letter to Shareholders, Buffett discussed the economic moat that Berkshire Hathaway’s subsidiary GEICO had:
"The difference between GEICO’s costs and those of its competitors is a kind of moat that protects a valuable and much-sought-after business castle. No one understands this moat-around-the-castle concept better than Bill Snyder, Chairman of GEICO. He continually widens the moat by driving down costs still more, thereby defending and strengthening the economic franchise. Between 1985 and 1986, GEICO’s total expense ratio dropped from 24.1% to the 23.5% mentioned earlier and, under Bill’s leadership, the ratio is almost certain to drop further. If it does - and if GEICO maintains its service and underwriting standards - the company’s future will be brilliant indeed."
Then in his 1993 letter, the proud chairman of Berkshire Hathaway (BRK-A) commented on his investment on Coke and Gillette:
"Moreover, both Coke and Gillette have actually increased their worldwide shares of market in recent years. The might of their brand names, the attributes of their products, and the strength of their distribution systems give them an enormous competitive
advantage, setting up a protective moat around their economic castles. The average company, in contrast, does battle daily without any such means of protection. As Peter Lynch says, stocks of companies selling commodity-like products should come with a
warning label: "Competition may prove hazardous to human wealth."
Companies with deep and wide economic moats can maintain their gross margin, increase their market share, and have the resources to expand geographically. Customer worldwide are willing to pay the higher price for their better perceived values compared to those of competitor’s products. Today, there is almost nowhere in the world where you cannot buy a Coke, a Gillette razor, or a McDonald’s big Mac.
Talking about the 99-Cent hamburgers, one is reminded of a fad that has been happening in the retail world: during the last 15 year or so, all of sudden, stores selling everything for a dollar sprouted up on every corner of the American cross-roads. One of these such stores even carries the name “99C Only Stores” (NDN, Financial). It sells everything from A to Z for exactly 99 cents, before tax, that is. Most of the stuff are made in china, usable but of the lowest tolerable quality. NDN started in 1982 and currently is operating 270 stores, mostly in California, Texas, and Arizona. The company has a market cap of $724 million and an annual revenue of $1.2 billion.
The trouble is, with a name like that, the company effectively preempts itself from any price hiking beyond $1. In recent years, China has supplied most of the inexpensive merchandises. Through frugality, cutting corners on quality, and questionable labor practices, China managed to keep the cost in check. However, year in and year out, eventually even the Chinese manufacturers could not contain the rising costs of material and labor with their shrinking margin and they had to pass the costs to downstream distributor. As a result, NDN has experienced a dwindling gross margin. According to Gurufocus, the company’s gross margin declined from 14.3% in 2002 to 2.2% during the fiscal year through March 2008. For the past twelve month through September 30, 2008, the gross margin has been -1%.
Where NDN couldn’t make with margin, it tried to make with volume. Annual revenue per share has increased from $2.36 in 2002 to $17. 68 for the twelve months ended on September 30, 2008, an incredible increase of 650%. Yet, despite of the impressive increase in revenue, NDN’s EPS has decreased from $0.18 in 2002 to a loss of $0.07 during the past twelve months. All that revenue for nothing!
NDN stock reached a high of $36 back in 2003 and has been hovering around $10 per share since early 2005. I personally think that it saw its best days, and I am not alone. Gurufocus Guru Chuck Akre had accumulated a position of 9.39 million shares by the end of 2007 and has been a net seller ever since. As recently as on Dec. 31, 2008, Gurufocus reported that Chuck Akre had sold his position recently down to 7.23 million shares; so far, Chuck Akre has reduced almost a quarter of his holdings in the company.
Also check out:
