Published September 28th, 2015
McDonald’s (MCD) and Starbucks (SBUX) are the two largest food/beverage restaurant chains in the world.
McDonald’s currently has a market cap of $91.9 billion, while Starbucks has a market cap of $86.1 billion. Both companies are around the same size.
Starbucks was founded in 1971. McDonald’s was founded in 1955. Over the last decade, Starbucks has compounded its earnings-per-share at a tremendous 17.9% a year. McDonald’s has delivered above average earnings-per-share growth of 10.9% a year.
In recent years, Starbucks has continued to grow rapidly, while McDonald’s has stagnated. The table below shows both companies expected earnings-per-share in 2016 and 2015, as well as historical earnings-per-share going back to 2010:
Note: All earnings numbers and estimates are from Value Line
You can clearly see that Starbucks has generated beautifully consistent earnings-per-share growth since 2010. McDonald’s on the other hand, has not. Earnings-per-share actually peaked for McDonald’s in 2013. The company is not expected to generate higher earnings-per-share until around 2018 – a 5 year period of stagnation.
Valuation & Growth Analysis
Starbucks currently trades for a price-to-earnings ratio of 32.8. McDonald’s has a price-to-earnings ratio of 19.9.
McDonald’s is quite clearly the cheaper of the two companies based on its significantly lower price-to-earnings ratio which is a result of no growth over the last several years.
Starbucks is expected to grow its earnings-per-share at around 15% a year over the next several years. The company will grow through a massive new store opening campaign. Store count is expected to grow at over 7% a year for Starbucks. The company is also expecting comparable store sales growth of approximately 5% a year from a mix of greater food sales and Teavana sales. Margin improvements and share repurchases will account for the remaining 3 percentage points of growth for Starbucks. Adding in Starbuck’s current dividend yield of 1.1% gives investors an expected total return of about 16.0%.
I expect McDonald’s to grow its earnings-per-share at around 7.5% a year over the next several years before comparable store sales increases. Earnings-per-share growth will come from:
- Share repurchases of ~3.0% per year
- Efficiency gains of ~1.5% per year
- Store count growth of ~2.5% per year
Adding in McDonald’s dividend yield of 3.5% gives shareholders an expected total return of around 11% per year.
To summarize, before changes in valuation, expected total returns for these two stocks are:
- 11% for McDonald’s
- 16% for Starbucks
If valuation didn’t matter, Starbucks would be the better investment. But… Valuation does matter.
Starbucks’ price-to-earnings ratio is 65% higher than McDonald’s. Over time, investors should expect Starbucks’ price-to-earnings ratio to slowly fall.
Starbucks will not grow at 15% a year forever. Eventually, the company will reach a maturation stage. When it does, its growth rates and price-to-earnings ratio will fall. Once Starbucks rapid growth slows and it reaches maturation, the company will likely see its price-to-earnings ratio fall to around 20 – which is about average for mature high quality businesses with strong competitive advantages.
On the other hand, McDonald’s is already a mature company and will likely be able to continue generating total returns in its current expected range. Most of the company’s returns come from dividends and share repurchases. Long-term investors in McDonald’s stock need not worry as much about permanent valuation multiple declines.
Additionally, McDonald’s could see greater total returns if it returns to comparable store sales growth.
Everything must go ‘right’ for Starbucks to prevent the company from seeing its price-to-earnings multiple revise downwards.
How Long Can Starbucks Grow?
The question investors need to ask themselves is: “how long can Starbucks keep up this level of growth?”
McDonald’s is certainly facing serious competitive challenges. How long until competitors find a way to chip into Starbuck’s brand and image?
McDonald’s itself has tried with its own coffee products, but the company has failed to match the ambiance and style that differentiates Starbucks from its competitors.
I don’t believe Starbucks has a monopoly on the ‘coffee shop feel’, however.
Just as Shake Shack (SHAK), Chipotle (CMG), and other new fast-food concepts have caused McDonald’s to falter, it is certainly possible for a similar course of events to happen to Starbucks.
The truth is no one knows how long Starbucks can keep up its excellent comparable store sales growth.
Starbucks primarily sells a luxury item – expensive coffee, whereas McDonald’s sells dirt-cheap (I think that’s a more apt description than MCD would care to admit) burgers. It is interesting to note the difference in performance of these two companies during recessions.
McDonald’s performed exceptionally well during the Great Recession. From 2007 to 2009, the company saw earnings-per-share rise 26%. From 2008 to 2009, earnings-per-share rose 8%. McDonald’s has a long history of success. The company is a member of the exclusive Dividend Aristocrats List – a group of 51 S&P 500 stocks with 25+ years of consecutive dividend increases.
Starbucks, on the other hand, saw earnings-per-share fall by 18% from 2007 to 2008. The company did quickly recover, and set new earnings-per-share highs by 2010. It is instructive however, that Starbucks sees slow or negative growth during recessions.
An investment is said to be anti-fragile when it gains from shock and disorder. McDonald’s is one of the few businesses that actually benefits from recessions. It is anti-fragile. Starbucks is not.
I believe Starbucks to be the better business between the two companies, but it is fairly close. In Starbucks favor, it sells a more addictive product (coffee withdrawals are real) and has a more well respected brand.
With that said, I believe McDonald’s stock to be the better investment today. This is because of Starbucks’ high price-to-earnings ratio and relatively poor performance (compared to McDonald’s) during recessions. Simply put, less has to go right for McDonald’s to generate above-average returns going forward for shareholders than for Starbucks to do the same.
McDonald’s has the higher dividend yield and a longer dividend history. The company has struggled recently. If McDonald’s returns to comparable store sales growth, the company will generate very strong total returns.
My opinion would reverse if Starbucks price-to-earnings multiple were decline into the mid 20’s or lower, or if McDonald’s price-to-earnings ratio were to rise.
McDonald’s ranks highly using The 8 Rules of Dividend Investing due to the company’s above-average 10 year growth rate, high dividend yield, long dividend history, and reasonable valuation. Starbucks does not have a long enough dividend history to be ranked using The 8 Rules of Dividend Investing.