Ignore the Sirens! Peak Fear is a Buying Opportunity
Kyle is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The most difficult task that any investor faces is leaving emotion at the door. There's always the temptation to chase the herd, especially when it's stampeding for the exit signs in fear of the unknown.
In retrospect, it should be obvious to every broker on Wall St. that fear invariably seeks a maximum level (“peak fear”) and that the optimum time to buy is when there are too many sellers. Picking the right stocks at the right price is a lot like crashing a Sorority Party on Halloween: Even the most attractive opportunities are wearing scary masks.
With that in mind, let's follow Mr. Buffett's oft quoted (but seldom heeded) advice to “be fearful when others are greedy and greedy when others are fearful” by taking a close look at the Strengths, Weaknesses, Opportunities, and Threats (SWOT) of an iconic American company: McDonald's. (NYSE: MCD)
SWOT: Strengths, Weaknesses, Opportunities and Threats
#1 Fast Food Restaurant: McDonald's Corporation is the world's largest chain of hamburger fast food restaurants, serving around 68 million customers daily in 119 countries. McDonald's has increased shareholder dividends for 25 consecutive years, making it one of the S&P 500 Dividend Aristocrats.
Most Recognized Brand: McDonald's golden arches are the most recognized symbol in the world: More recognizable that the dollar sign, the crucifix, Yin and Yang, Olympic Rings, the Peace Sign, Radioactive warnings, atomic symbol, the Crown, Stop Sign, Stars and Stripes, and Smiley Face. McDonald's iconic Ronald McDonald is one of the most popular and recognizable characters in the world.
Franchise Model: The McDonald's Corporation's business model is slightly different from that of most other fast-food chains. In addition to ordinary franchise fees and marketing fees, which are calculated as a percentage of sales, McDonald's often owns the underlying location property and collects rent. McDonald's has become emblematic of globalization, a phenomenon sometimes referred to as the "McDonaldization" of society. Comparing the cost of similar McDonald's menu items around the world is a quick way to calculate a given currency's Purchasing Power Parity. (PPP)
Cash Cow: Including revenue from its franchise stores, McDonald's would rank as the world's 68th largest economy if it were a country.
#1 with Kids: McDonald's is the world's largest distributor of toys, with one included in 20% of all sales.
Retail Footprint: The only place in the lower 48 that is more than 100 miles from a McDonald's is a barren plain in South Dakota.
Excellent Corporate Governance: McDonald's reputation as one of the best-run corporations in the country. McDonald's has executed a turnaround that's driven profits and shares up for nearly a decade. McDonald's market share has either held or increased in all of its major markets, despite industry weakness.
McDonald's continues to grow. It has a steady profit margin of 20%, a steady operating margin nearer to 30%. The balance shows as much cash as a typical quarter shows gross profit, so it can handle the shocks that a global company is heir to.
Multi-Nationals are Being Hit by Europe: McDonald's, as well as other iconic global brands such as Coca-Cola (NYSE: KO) have taken a hit to growth due to the slowdown in Europe, though both companies have demonstrated more resiliency than most on the Continent. (Coca-Cola quickly returned to growth in 4 out of 5 of its European business units over the same time frame.) The hit to same store sales (-1.8%) has jarred many investors, although McDonald's Q3 2012 result still exceed previous results of the past 9 years if 2011 is excluded.
Emerging Markets are Slowing Down: Consumer confidence in Japan, Australia and China is still fragile, while emerging markets have been generally flat. McDonald's sales in China were up +3.6% in Q3 2012 vs. 11.3% Q3 2011 in Tier I and II Chinese cities.
Margin Compression: Rising commodities prices, labor costs and strategic investments (i.e. Olympics) are all putting McDonald's margins under pressure. The informal eating out industry within the U.S. is predicted to be flat in 2013.
Different Tastes: Guest comps, or the number of orders sent back by customers and thrown away, has increased in Asia/Pacific, Middle East and Africa or APMEA.
Expansion: McDonald's $1.5 plan to open an additional 1,300 stores around the world is a solid bid for market share, when you consider that many of the stores currently in existence have yet to recieve the full benefits of customer loyalty have steadily accrued for McDonalds in more mature markets.
Decline in Consumer Spending: As goes the Economy, so goes McDonald's. One of the greatest threats McDonald's is currently facing is that the same channels that previously contributed to the company's steady growth over the past two decades are now systemically important to the company; while at the same time, McDonalds is facing stiff competition in mature markets from competitors with fewer international entaglements. Mcdonald's rival Wendy's (NASDAQ: WEN), was able to post a solid same stores increase in Q3 of +2.7% while retaining excellent profit margins (13.9%) precisely because the brand does NOT have significant European/Asian exposure. Continued global weakness has the potential to threaten McDonald's top line growth.
New Nutrition Standards/Health Consciousness: NYC Mayor Michael Bloomberg's infitada against up-sized drinks and french fries, as well as California's recent ban limiting the number of fast food chain restaurants within the state are both widely regarded as the tip of the spear for the health conscious wave of reforms poised to sweep through the U.S. like a prairie fire. While McDonald's is voluntarily reducing portion sizes in an effort to get out in front of coming federal menu-labeling requirements, the company's success or failure will ultimately ride on how nimbly McDonald's management navigates the changing regulatory landscape.
It's a well-worn paradox that investors lock in profits by buying, not selling. Case in point: When the bottom fell out of the market in 2008, investing pundits were screaming "Sell! Sell! Sell!" Two years later, the cover of Newsweek read "America's Back!," and the same pundits who told you to cash out your 401K and invest in a fallout shelter were groaning in the newspapers about how all the "easy money" had already been made.
What made the money that investors who bought into the market while the DOW was shedding 700 points a day easy? Because picking a winner didn't require much effort. Virtually any competently managed company with adequate cash-flows and a proven business model would do. You didn't have to be a raving genius, you just had to ignore the sirens and all “The End is Nigh” prognosticators.
In the past two downturns/technical recessions, McDonald's investors have made easy money by buying the dips and selling the rips. As our SWOT analysis indicates, McDonald's positives continue to outweigh the negatives going forward. However, it's also important to pick the correct entry point: Peak Fear. Therefore, I recommend that investors hold off equity purchases until the S&P drifts below the psychologically important 1,200 mark.
Drink Up, Investors
There is absolutely no question that Coca-Cola has been great to long-term shareholders, but the company faces some new threats to its continued market dominance. The Motley Fool has recently compiled a premium research report containing everything you need to know about Coca-Cola. If you own or are considering owning shares in the company, you’ll want to click here now and get started!
FatalX has no positions in the stocks mentioned above. The Motley Fool owns shares of McDonald's. Motley Fool newsletter services recommend The Coca-Cola Company and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.