Fast sales growth is one thing, but what income investors really prize is cash flow. It’s cash that funds those regular dividend payments, and cash that determines how quickly a company can boost its annual payouts in the future. Earnings move up and down for many reasons, but, as the saying goes on Wall Street, “cash flow is destiny.”
If you screen for stocks based on the cash-flow metric, you’re bound to see McDonald’s (MCD) pop up time and again. The fast-food specialist generates close to $9 billion of operating cash flow per year, or nearly 40% of its sales. That’s just one of many reasons to like this dividend giant’s stock right now.
McDonald’s is covering the fundamentals
One key reason why McDonald’s is so much more profitable than its industry peers is that it receives a steady stream of fees from its army of franchisees. Yet the company’s long-term growth still depends on its ability to satisfy fast-food fans with an unbeatable combination of quality, value, and convenience.
Focusing on these fundamentals has been paying off for the business lately. McDonald’s in the second quarter reported a blistering 12% comparable-store sales increase that included a 10% spike in the core U.S. market. Contrast that result with Chipotle or Shake Shack, which expanded sales last quarter at 7% and 3%, respectively. “Our second quarter results reflect consistently strong execution,” CEO Chris Kempczinski told investors in late July.
McDonald’s is investing in growth initiatives
McDonald’s finances are just as tantalizing. The company’s operating profit margin is above 40% of sales, and earnings jumped 25% last quarter after adjusting for currency swings.
Mickey D’s has generated $4.1 billion of operating cash flow in the past 6 months compared to $2.8 billion a year ago. These resources give management all the flexibility they need to continue investing in growth initiatives like online ordering, home delivery, marketing, and new product introductions.
They also easily help fund a growing dividend payment currently yielding 2.4%. McDonald’s in 2022 hiked its dividend by 10% following a 7% increase in the prior year. While consumer spending trends are weakening and the economic outlook is cloudy, the chain’s strong earnings performance this year is laying the foundation for another aggressive increase ahead for fiscal 2023.
What’s the right price for McDonald’s stock?
These positive factors wouldn’t mean much if the stock was priced to reflect all of McDonald’s strengths. Yet investors aren’t taking on a big risk of potentially overpaying for the business. Instead, you can own this high-performing business at an attractive discount. The stock’s price-to-sales ratio has shrunk to 7.7 from a high of nearly 10 back in May. And rather than paying over 30 times earnings, investors are looking at a price-to-earnings (P/E) ratio of 23 right now.
Sure, some of that decline can be explained by real concerns about a slowing global economy. McDonald’s focus on value helps protect the business during those periodic cyclical downturns, but no consumer-facing business is totally immune to a recession. The chain might see lower customer traffic overall, for example, and less demand for its more premium menu items. Demand for home delivery would likely stall if fast-food fans switch to a more cautious approach to spending.
But McDonald’s has thrived through many downturns in the past, as confirmed by its track record of 46 consecutive years of dividend increases. Watch for that streak to extend through the next several years whether or not a recession impacts the fast-food industry.
— Demitri KalogeropoulosWhere to Invest $99 [sponsor]
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Source: The Motley Fool