7 Core Growth Stocks for Your Portfolio - McDonald's
Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
What do you immediately think of when I mention the Ronald McDonald, Big Macs, and Happy Meals? I'm assured that every reader immediately thinks of only one company - McDonald's (NYSE: MCD). Great brand strength and a visible growth trajectory means this company belongs as a core holding in your portfolio.
Why it's a core stock
The question above demonstrates the global strength of the McDonald's franchise. According to Interbrand, the Golden Arches ranked as the seventh most recognized logo globally in 2012. A strong brand and enormous scale represents a sustainable competitive advantage and allows the company to earn the high returns for shareholders.
Now many investors mistakenly assume that because there's a McDonald's on every street corner that the company has exhausted all of its growth opportunities. As a mature business, McDonald's is doomed to a fate of slow, anemic growth.
But nothing could be further from the truth. In fact, McDonald's is exposed to the most biggest investment opportunity in history - Asia's emerging middle class.
According to the McKinsey Global Institute, India's and China's middle class numbers at 610 million people today. But by 2030 that figure could hit 1.6 billion people as these nations rapidly industrialize.
And McDonald's is on the front line of this trend. McDonald's has 1,700 locations in China today with plans to increase that total to 2,000 by the end of the year. But this is only the beginning. In America, there's one McDonald's restaurant for every 22,000 consumers. If the company can achieve half of that penetration in China the country could support 30,000 outlets. That's nearly double the size of the company today.
That's a long growth runway.
In addition McDonald's is only just starting its expansion in India. The company has only 250 locations in the country today with plans to double that total by 2014. India too represents an enormous market on par with China.
Better yet McDonald's has a long history of rewarding shareholders with the company increasing its dividend for 35 consecutive years. Today the stock yields 3.1% and those payments are likely to continue to grow as the company expands internationally.
Risks to watch out for
Of course as with any good growth story it comes with risks that investors need to be aware of.
First - many analysts are skeptical that McDonald's can adapt its menu to meet local tastes.
McDonald's has addressed this concern with mixed success. In India, the company has revamped its menu featuring entirely beef and pork free offerings. However earlier this year in China, McDonald's new rice platter was greeted to poor reviews.
Second - other companies illustrate just how difficult emerging markets are to operate in.
In June, Starbucks' (NASDAQ: SBUX) Hong Kong division admitted to using toilet water to brew coffee at one of its stores. Water was taken from a restroom tap because the location had no other supply. The company issued an apology but customers are still furious.
Starbucks is in the midst of a major expansion in China with hopes to double the size of its footprint in the country to 1,500 cafes within two years. The stock's premium 35 trailing earnings multiple hinges on this aggressive growth plan. If customers avoid Starbucks following this scandal, it could derail the company's expansion and its share price.
Yum! Brands (NYSE: YUM) illustrates this point. In January the company reported Chinese same store sales declined 41% after it was announced that its KFC branded chicken had high levels of antibiotics. In April, comparable sales fell another 29% following Avian flu fears. This is particularly alarming because China accounts for 50% of the company's sales.
However there's some good news for Yum! investors. During the company's conference call last week management noted that its China business is "recovering as expected" and sees China same-store sales turning positive by the fourth quarter. Now that the company is running into easy comparables, it could be a catalyst for a higher share price.
However, what's troubling for investors is that neither of the incidents above could have been predicted. It's a risk McDonald's shareholders will have to accept.
Foolish bottom line
McDonald's incorporates both of the traits needed to be considered a core holding in your portfolio - a sustainable competitive advantage and great growth prospects. At 18 times trailing earnings the stock isn't cheap, but investors shouldn't be afraid to pay a premium given the strength of the underlying business.
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Robert Baillieul has no position in any stocks mentioned. The Motley Fool recommends McDonald's and Starbucks. The Motley Fool owns shares of McDonald's and Starbucks. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!