Since going public in the 1960s, McDonald’s (NYSE: MCD) has likely minted more than a few millionaires, given its sensational stock returns. The company has opened tens of thousands of restaurant locations worldwide since going public. And it outsourced much of its restaurant operations to third-party franchisees, boosting corporate margins.
But is it too late to buy McDonald’s stock in 2024? Well, that depends on what you’re looking for. Here’s what investors can expect and shouldn’t expect from a McDonald’s investment right now.
Here’s what not to expect
Allow me to lay the theoretical foundation for what to expect: Stocks go up when there’s high investor demand. Over the short term, demand can be driven by the news or other unpredictable factors. But over the long term, demand is driven by a company’s earnings, which is more predictable.
Therefore, if earnings go up, a company becomes more valuable to investors. So, what about future earnings for McDonald’s?
For McDonald’s, its earnings per share (EPS) have grown at a nice pace over the last five years even though it’s already a large, mature company. As the chart below shows, EPS growth is outpacing revenue growth.
McDonald’s gets most of its money from its franchisees in the form of franchise fees, royalties, and rental payments. This is a high-margin source of revenue and it generally ticks higher at a modest pace. And by repurchasing shares, EPS goes up at a faster pace than revenue.
Looking ahead, McDonald’s is probably going to grow EPS at a single-digit annual rate as it has in recent years. Therefore, I believe investors are unlikely to lose money. But the modest growth opportunity means that investors shouldn’t expect returns to necessarily crush the performance of the S&P 500.
It’s probably too late to invest in McDonald’s stock hoping for that market-crushing performance and recent results support this view. McDonald’s stock is underperforming the S&P 500 over the last five years and is an average performer over the last 10 years.
More realistic expectations
There can be reasons to invest in a company such as McDonald’s besides trying to outperform the S&P 500. For some investors, a high probability of making money and stable dividend income can be strong motivating factors. And McDonald’s is attractive from that standpoint.
I’ve already pointed out that McDonald’s generates high-margin revenue because it’s primarily a franchisor of its restaurants. This high-margin revenue is a big reason that the company has money to consistently pay a growing dividend.
Revenue for McDonald’s is consistent as well because it isn’t primarily tied to sales but rather to what the company makes from its franchisees. Now, this does present a risk that’s worth mentioning. The franchisees are the ones who have to grapple with food and labor inflation. And in some markets, that’s harder than ever.
For example, in a recent interview with Fox Business, California franchisee Scott Rodrick said that he’s currently focused on “survival” in light of the state’s new minimum wage law. It could be modest hyperbole on his part. But if Rodrick is worried about survival, it’s likely on the minds of other franchisees as well. McDonald’s will have to help these businesses navigate high input costs coupled with limits to how high they can raise menu prices.
This is important. In 2023, McDonald’s generated revenue of $15.4 billion from its franchisees — $9.8 billion of this was from rental payments because McDonald’s often owns the real estate that its franchisees use. For perspective, its franchisee revenue in 2023 was up 18% from 2021.
Therefore, growth in revenue from its franchisees is driving overall growth for McDonald’s as well as its positive stock returns. The company needs its franchisees to be in a healthy place if this is going to continue.
It’s easy to cherry-pick a place like California and get worried about the health of franchisees. But McDonald’s has nearly 42,000 locations worldwide and many have already made it through the highest levels of inflation. I don’t think investors need to worry.
To me the most likely outcome is that the restaurant industry will adjust to present headwinds as it has in the past. Most of the franchisees for McDonald’s will endure and revenue for McDonald’s will remain intact and modestly increase in future years because it owns much of the real estate. Ongoing share repurchases will boost its EPS, which should lead to a higher stock price.
McDonald’s stock offers a good chance to make money with modest stock gains and a growing dividend. But I wouldn’t necessarily expect it to be a top stock performer in a portfolio.
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Jon Quast has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
Is It Too Late to Buy McDonald’s Stock Now? was originally published by The Motley Fool