Investors might have avoided some consumer discretionary stocks due to growing inflation concerns and rising credit card delinquency rates. When personal finance conditions become so tight, consumers tend to restrict their spending to only the necessities for everyday life, a category under which shares of McDonald’s Co. (NYSE: MCD) surprisingly fit.
After briefly selling down on the disappointing results from a new cheap meal to help consumers breathe a little more, McDonald’s stock has now recovered to trade as high as 96% of its 52-week high. If the company can keep this momentum going, it might as well make a new 52-week high on continued strength from the affordability this restaurant stock offers the public.
But, as always, there has to be a catalyst to close down the stock's fair value and bring the price closer to it. Today, this catalyst comes as a Wall Street analyst boost, an unlikely move considering that other stocks in the sector had taken the momentum place, particularly shares of Starbucks Co. (NASDAQ: SBUX) after a double-digit rally. As there can be more than one winner at a time, here is why McDonald’s might be a stock worth taking a second look into.
McDonald's Earnings Cycle Pave the Way for Higher Stock Prices Last Quarter
But that wouldn't be as obvious to many, as the company did report lower sales and lower earnings per share (EPS) across the board, which is never good news for a company. This company, however, is a bit different; McDonald's has squeezed so much profit from its brand moat that these current slowdowns barely make a dent.
Over the past five years, covering McDonald's pre-COVID and post-COVID financials, investors will notice one primary trend. Net income margins were up, which results from a company's operations accounting for issues like cost inflation and sales fluctuations.
McDonald's generated a net income margin of 28.2% in 2019, which was only higher by roughly a percentage point from 2018. Now, the theory states that net income margins should move somewhere close to inflation since cost inflation would have been taken care of through the cost of products and operating expenses.
The thing is, McDonald's saw its net income margin jump to 32.5% in 2021 during a time when costs were on the rise and wage inflation was also an issue. Logically, these margins should have stood within pre-COVID ranges, if not lower, and the only way to keep them rising is by raising prices faster than costs went up.
Because McDonald's has already penetrated so much of the restaurant market, raising prices is not an issue, so 2023 net income margins came in at 33.2% to significantly outpace any cost inflation experienced after COVID-19. This is a great strategy when a brand is this big but eventually stops working.
McDonald's scared off some of its most loyal customers looking for an affordable alternative, so the company had to offer a $5 combo to offset declining sales. While that worked for a while, the trend is clear. McDonald's must retrace some of its net income margin to historical levels to keep previous sales volume.
Wall Street Analysts Confident in McDonald's Return to Previous Performance Levels
Even if prices do come down to normalize net income margins, analysts seem confident that McDonald’s will offset these price decreases with the return to more normal demand patterns. More than that, the brand’s international presence is set up to help it cushion any other fluctuations that may come its way.
Currently, the forecast for EPS growth is 7.9% in the next 12 months, an impressive rate considering the company’s maturity and size. More than that, analysts at Evercore decided to boost McDonald’s stock price target up to $320 a share as of August 2024, predicting it to rally by as much as 10.4% from where it trades today.
Wall Streeters weren’t the only ones willing to share their optimistic outlooks for McDonald’s stock, as the company’s management decided to reinvest a significant amount of capital back into the business.
Over the past quarter, management repurchased up to 12.3 million shares from the open market for a net transaction of over $3.5 billion, representing roughly 2% of the company’s market capitalization today. Even if the stock takes longer than anticipated to reach current price targets, investors can rest assured of the 48-year track record of dividend increases.
The latest payout is $6.68 a share, which translates to an annualized dividend yield of up to 2.3%. McDonald’s is known to not only pay this reliable dividend but also raise it every year to enable investors to keep up with inflation, just like the stock did by raising prices and keeping net income margins at record highs.
