McDonald’s Corporation (MCD): A Time For Caution

The stock over the past decade trades at an average price-to-earnings (PE) multiple of 15.9; today its PE is more than 22. That’s relatively pricey in historical terms and up there with the rest of the market.

I’m not in favor of spending billions of dollars every year to buy back stock. If cash flow is so great and so regular, why not reward stockholders with higher dividends? Dividends are more tangible. All that money spent on buybacks can go down the drain if the stock collapses in a market rout. If cash flow is strong enough to keep up healthy dividend payments and the stock drops, it becomes more enticing for existing stockholders to average down, knowing they will increase their dividend yield, and the stock becomes more attractive to new investors for the same reason.

Buybacks, to me, are a signal that management is more inclined towards financial engineering to support the stock price as opposed to good-old company growth and margin expansion moves.

I’m going to wait to see what happens with McDonald’s menu changes, see how their profit margins go, see how they apply their cash, see how new CEO Steve Easterbrook handles the franchisee backlash and wage issues, and see what Mickey D’s competitors do before considering the stock.

There’s a lot to like about McDonald’s, if management gets it right. The play for me will be seeing if changes create instability in the stock and an opportunity to buy it lower.

I’ll buy shares if it slides enough and if, at the same time, I like what management is doing to “recreate and refresh” the global icon McDonald’s used to be.

If I owned the stock, I’d certainly want to put in a floor in case the price falls on account of questions about what changes are coming, or not coming. Below $94 the stock would start to worry me. One protective play would be to buy $94 strike price put options a few months out. They’re cheap insurance in case the stock falters at that level.

Generally, I’m inclined to take profits – especially when my stocks have had a nice run, as McDonald’s has. If I owned the stock and it moves higher I’d be looking to take profits near its highs around or over $103 and consider re-entering at lower levels.

While McDonald’s can do a lot with its stores and menu, the stock isn’t likely to jump substantially any time soon. That’s why taking some profits or protecting your gains now makes sense.

Money MorningWritten By Shah Gilani From Money Morning

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