I can’t think of a stronger and more robust business model than McDonalds (MCD), and who can argue otherwise? This global fast-food giant dominates in almost every country around the world, and is currently expanding voraciously through much of Asia. Travel anywhere around the world, and you will find a McDonalds for a safe and cheap place to eat. McDonald’s has also been a stellar stock to own since January 2003, when it was trading at only $14 per share. Unlike the food it produces, McDonald’s stock is no longer a cheap deal.
McDonalds was one of my Stock Picks for 2011 in December 2010. I also recommended MCD in Three US Stocks For Your RRSP back in October 2010, when MCD was trading at $74.51 per share. The future prospects for McDonalds look excellent and the company looks poised for solid growth in 2012. The Dividend Monk also invested in MCD recently. He’s cautious, but long-term bullish. I really like McDonalds. I like the business model and I even like the new Angus burger with Bacon – it’s a delightful box of cholesterol. So why would I be crazy enough to even consider selling this winner? Have I lost my dividend marbles?
Earnings, Price, and the Dog on a Leash
Back in 1998 investors also thought McDonalds was a sure thing, which it was, but the price became quickly overvalued. McDonalds reached a high of $45.31 in January 1999, and then declined a whopping (not whopper) 68% to a low of $14.46 in January 2003. While MCD is a solid company, the share price and PE Ratio are once again trading at all time highs. MCD is currently skirting the $100 mark at $98 per share, with a PE Ratio of over 19. While others are buying MCD, I feel this may be either a good time to sell and take profit, or hold on and wait for the dips to buy more. The long term chart of McDonalds below shows a stock that is soaring to all time highs.
In his recent best-selling book Millionaire Teacher, Andrew Hallam likens the run of a stock price from its earnings, like a dog on a leash. He writes how no matter how much a stock price rises, it is always bound by its earnings, and if the share price rises too quickly it will always come back to its average price bound by its earnings – just like a dog on a leash. He demonstrated this principle using the Dividend investor’s favourite, Coca-Cola (KO). This was from an excerpt of Andrew’s book, Conquer the Enemy in the Mirror, which was also published in MoneySense Magazine:
“The stock market is exactly like a dog on a leash. If the stock market races at twice the pace of the business earnings for a few years, then it has to either wait for the business earnings to catch up, or it will get choke-chained back in a hurry. But a rapidly rising stock market can cause people to forget that reality.” (Andrew Hallam, Millionaire Teacher, pg. 69)
Andrew gives a great example of Coca-Cola from 1988 to 1998 when its earnings increased over 294% for that decade, but the share price soared 996% over the same period. Andrew shows this on figure 4.1 of Millionaire Teacher (pg.69). Not surprisingly, the price of Coca-Cola then declined substantially from a high of $85.50 per share in April 1998, to a low of $40.31 per share in October 2005. It is inevitable that the value of a company (its share price) can only exceed its earnings to a limited amount and period of time – even McDonalds which is now approaching $100 per share.
Why I Bought McDonald’s
Back in March 2011 I purchased McDonalds (MCD) at $75 per share. I was limited with investing capital at the time, and didn’t want to sell my bond ETF holdings, or I would have purchased more. When I purchased MCD in March many considered McDonalds overpriced, and others like myself, saw a great price entry point. This was after a small retreat from its high of $80.34 per share back on December 7th, 2010. At the time McDonalds also had a PE Ratio of around 15, but that PE Ratio has now climbed up to over 19. I’ll cover this metric in Part-2, but to place this in context the Dow 30 has an average PE Ratio of 16, and MCD now has the third highest PE Ratio of the Dow 30 (though comparing CISCO to MCD is like comparing apples and oranges, and I’ll cover that point in Part-2).
Why I’m Selling McDonald’s
When I purchased McDonalds, I made the commitment with my order that if McDonalds reached $100 per share I would sell, and take my profit – a nice 33% profit in a few months. If it went lower, I would do what most dividend investors do, wait and buy more on the dips and dollar cost average my position. Since McDonalds is not a stock to lose sleep over, and I am comfortable with it as a core holding, I felt this was a winning scenario either way it unfolded.
I have a sell order on MCD at $100 per share, until the end of December. If MCD doesn’t reach that sell point, and the share price declines, then I will top-up on the dips. Regardless, I have my dividend income on MCD at 2.90%, while I’m waiting to see what happens next. For me, it’s a winning scenario either way!
In Part-2, I’ll discuss more about McDonalds. I’ll look at the Price to Earnings relationship in more detail, the PE Ratio, and elaborate further on selling for profit versus a buy-and-hold strategy.
Readers, What’s your take on McDonalds (MCD)? Buying or Selling? Do you like the Angus burger?