Don't Discount the Golden Arches

 | Oct 24, 2013 | 11:00 AM EDT
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During the last few weeks and months, we have seen a broad based market rally that has lifted most boats in its rising tide. While we are enjoying these strong gains and believe they have been warranted by economic conditions and market fundamentals, we are wary about chasing the 2013 winners. So we suggest that investors be more discerning when putting new money to work.

Conversely, investors should not be shy about taking profits if individual holdings have reached their target price or appear richly priced.

McDonald's (MCD) has missed the entire rally but we think is poised to provide solid gains in the upcoming year. The company announced quarterly earnings earlier this week and beat the estimates by 1 cent at $1.52. The stock sold off a bit on the news because the revenues were a tad light at $4.92 billion vs. $4.94 billion for the consensus estimates. Furthermore, the analysts were underwhelmed with the company's current business trends, with October same-store comparison trends trending flat.

During the third-quarter earnings conference call, many analysts expressed a tone of overall frustration with the company. These concerns revolved around the company's sluggish top-line sales environment. Management blamed a large portion of the shortfall on weak macro-economic growth throughout North America, Europe and Asia. However, many of the analysts were also frustrated with rising levels of competition and lack of innovative new product offerings. For example, McDonald's "Mighty Wings" launch was a disappointment during the quarter.

As a result of this disappointing release, McDonald's shares have continued to tread water. Year-to-date, the shares are up a little more than 6.8% vs. the S&P 500's increase of 22.5%. 

Fortunately, outside of the short-term frustrations and its recent slow business progress, we think that MCD is poised for better business trends in the upcoming year. The company continues to gain market share and it is adding more than 1,000 new restaurants worldwide in the upcoming year. Sales should also be aided by new company initiatives around the "Dollar Menu & More," offerings as well as specialty sandwiches and wraps. Furthermore, an improving economy in Europe and the U.S. would add to its growth prospects.

In addition, the stock is reasonably priced, trading at 15.5x 2014's EPS estimate of $6.07. The company also pays a high dividend of 3.4%, which we expect to grow 6% to 10% per year. The favorable valuation and dividend yield should provide a good level of protection in the event that the market takes a breather and pulls back.

We like MCD and believe it should be a major beneficiary of any return to normal economic growth. Bottom line, MCD presents an attractive opportunity for prudent investors thanks to its strong business franchise, positive long-term growth prospects, favorable valuation level and above average dividend yield. 

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