Are These 2 Stocks Overvalued?

David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

If you are interested in investing in burger chains, McDonald's (NYSE: MCD) and Wendy's (NASDAQ: WEN) are two obvious choices to start looking at. They are in remarkably different situations: the former is looking to milk new revenue segments after saturating domestic markets; the latter is looking to turnaround its business. Will they succeed? Below, I present my outlook on the two companies.

Expansion is the key for McDonald's

McDonald’s has been, for some time, thought of as "China growth" story. Currently, less than 3% of the profit comes from this emerging market, and there is a huge opportunity with Yum! Brands, the current leader, slowing down. However, the company has plenty of opportunities.

One opportunity comes in the form of targeting more middle-income Americans. To succeed in this, the firm is opening a new state-of-the-art restaurant in Maine, which is supposed to contain the newest interior and kitchen designs, and after months of revisions, it was finally approved. Other relatively classy McDonald's joints have been opened elsewhere, such as in California. It's an experience worth trying to shift away from the economy-dependent low-income demographic.

All in all, McDonald's is one of few big companies that is constantly seeing a higher growth in sales and workforce. It is seen as a bellwether of the macro economy and has largely recovered since the October slip up. With various new growth opportunities from the creation of upper scale joints to penetration in China, the company can catalyze its growth beyond normal market rates.

My one concern is whether the stock is overpriced. At 18.4 times trailing earnings, it is slightly expensive compared to the current 17.2x PE multiple for the S&P 500. I also believe that the 9.8% growth rate expectation may be a bit too optimistic.

Expansion shouldn't be taken for granted, especially when considering that new restaurant shops -- like Buffalo Wild Wings (NASDAQ: BWLD), Chipotle, and Panera -- are opening and spreading across the nation. Rising food costs are also eating into margins.

If you opt to invest in McDonald's, I encourage hedging it with a company that is on the verge of national expansion: Buffalo Wild Wings. Buffalo is projected for a 20%+ growth rate, and it is safe with 30% less volatility than the broader market. It has around 3% the number of restaurants that McDonald's has, but around 3.8% the revenue. At such an early stage, Buffalo is performing quite well with fewer restaurants.

Will innovation save Wendy's?

Relatively recently in Las Vegas, two real estate investment groups bought out 18 Wendy’s locations for $23.7 million. While it's not exactly exciting news, it's certainly telling. This has been the general business strategy: (1) downsize the business and (2) yet market the company as a "premium" brand. These strategies are, of course, largely contradictory and illustrative of a company that is in decline.

What is Wendy’s doing to bring customers back into restaurants? It is reviving its Fish Fillet sandwich, which is expected to generate higher-than-expected income for the specified period. It admittedly did the same thing last year when it released Dave's Hot 'N Juicy burger to much success.

To further strengthen its position as a premium burger shop, it is also testing the introduction of a bread bun shaped like a pretzel. The bun was sold as a Pretzel Bacon Cheeseburger in Miami, where it was available during the testing period. Its sales were successful, and the price of $0.99 was well received.

But, the momentum has been largely felt on the Street. The stock is now up more than 35% from the 52-week low, and it trades at 27.5 times forward earnings. But it is just starting to move into profitable territory. I find the stock overly expensive right now and with little clarity over growth.

Conclusion

In my view, McDonald's and Wendy's are expensive stocks right now. Both have already saturated much of the market, and consumers are looking for a different bite to eat. The sudden rise of Chipotle, Panera, and Buffalo prove that new is often better. Unfortunately, McDonald's and Wendy's are just not that and at current prices, they appear overvalued.

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David Gould has no position in any stocks mentioned. The Motley Fool recommends Buffalo Wild Wings and McDonald's. The Motley Fool owns shares of Buffalo Wild Wings 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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