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McDonald's Trading at a Tasty Price

I have devoted many of these columns to stocks that offer promise on the basis of their potential to appreciate and their valuation metrics (which often come with short-term volatility) or their healthy income stream and price stability in a choppy stock market.

Today we focus on a company that is attractive on both counts. McDonald's (MCD - Get Report) is a good example of an all-weather stock. We believe it offers investors not only reasonable appreciation potential but also an attractive income level and the stability of an iconic and well-run business.

McDonald's is the premier global fast-food restaurateur. The company primarily franchises, but it also operates more than 34,000 restaurants globally under the McDonald's brand name. During the most recent quarter, McDonald's reported weaker than expected earnings of $1.32 per share, compared with $1.38 consensus. Furthermore, July same-store comp sales also disappointed with flat results vs. expectations of a 2.7% increase.

The current weakness is entirely due to broad global macro weakness seen throughout Europe and Asia. Investors are still a bit cautious on the stock, and that has led to a 10%-plus correction in the stock price. Nevertheless, management is still positive on company execution and has maintained long-term guidance of 7% to 8% revenue growth and 8% to 10% earnings growth.

From a valuation perspective, McDonald's, though not cheap, is reasonable. The stock is trading at 16.75x 2012's EPS estimate of $5.41 and 15.5x 2013's EPS estimate of $5.85. Historically, the stock has traded for greater than 16x earnings. McDonald's has a strong A++ investment-grade credit rating and a 53% payout ratio. For the past decade, the company has consistently increased revenue 8% per year and earnings 12.5% per year.

From an income perspective, McDonald's looks surprisingly strong. The shares currently have a 3.1% dividend yield, and we expect that to increase to 3.4% to 3.5% when the company reviews and raises its dividend later in September. Impressively, the company has raised its dividend every year for the past 10 years. We expect that McDonald's will continue to raise its dividend in line with its long-term growth rate at 8% to 10% per year because of continued global expansion, margin improvements and stock buybacks. (While dividend growth has been even greater than that during the past five years, we expect the pace to slow and to more closely track earnings growth.)

Bottom line, investors are buying one of the world's pre-eminent brands with good growth prospects, strong financials and a very attractive, growing dividend at a price that looks reasonable compared with its historical norm.

If you're looking to supersize your investment, MCD should be a good choice.

At the time of publication, Matrix clients in Matrix's Dividend Equity strategies owned and continue to buy MCD. David Katz does not own MCD. There are no other conflicts of interest.

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