This American icon speaks to capital efficiency
June 4, 2019

From Stansberry Research:

Bear markets are scary for a reason...

The idea that you ought to buy and hold stocks even though you know a bear market is approaching or intensifying will seem like nonsense to a lot of investors.

But we're not talking about just any stocks...

In a bear market, you should focus on buying what we call capital-efficient stocks. These are companies that tend to outperform their benchmark indexes when the economy turns sour.

One of the reasons it's safe to buy capital-efficient companies during bear markets is because they can support their share price.

These businesses can do this because they're producing so much cash with their operations.

In fact, a great test of any capital-efficient company is whether it's producing enough cash to buy back all its outstanding shares. This determination combines the stability of a company's cash flows (which is necessary for a high credit rating and access to cheap capital) with its cash earnings power and a low share price.

These are the three most critical factors for a successful bear market investment. Longtime Stansberry Research readers will recognize the phrase. It's a theme we've covered a few times already in Stock of the Week with chocolate maker Hershey (HSY) and homebuilder NVR (NVR).

Today's company is one of the top capital-efficient stocks we follow. It also popularized the cost-saving restaurant "franchise" model...

Fast-food tycoon Ray Kroc didn't invent the hamburger... But he stumbled onto something special when he met the McDonald brothers. Since Mr. Kroc opened the first McDonald's (NYSE: MCD)franchise in 1955, it has become a trusted name with beloved products worldwide.

McDonald's is now one of the world's most recognized brands, in the league of Apple (AAPL) or Coca Cola (KO). Its roadside "golden arches" are unmistakable. Its classic "Big Mac" burger has become a symbol of American culture... And today, the company has more than 36,000 restaurants in more than 100 countries across the world.

It's one of the largest restaurant chains in the world, with a giant market footprint. And the company is still branching out into areas that can expand its reach and improve customer experience.

In 2017, McDonald's partnered with ride-sharing firm Uber's food-delivery service Uber Eats. The alliance allowed McDonald's customers to get their burgers and fries delivered straight to their door.

McDonald's is already reaping the rewards. According to Chief Financial Officer Kevin Ozan, the average delivery order check is double that of the average in-restaurant check.

And the company pioneered one of the most capital-efficient business models in the restaurant industry.

You see, when McDonald's got its start, many food chains owned each restaurant. This is a very cost- and labor-intensive business model. So McDonald's started "franchising" its restaurants. By doing this, the owner of the physical restaurant must put up all the capital to run it.

McDonald's lends its name and managerial expertise, at a fraction of the cost of owning and running the store itself.

The best part is McDonald's gets to sit back and collect royalties as the restaurants bring in cash.

This business model is a perfect example of the capital-efficient businesses we look for... And like other capital-efficient businesses, McDonald's oozes cash.

Over the past 12 months, McDonald's has reported $21 billion in sales. $4.6 billion of that trickles down to one of our favorite measures – free cash flow (FCF).

This is the one metric we value most.

FCF is simply a measure of a company's "cash profits" minus "capital expenditures" – or "capex." (Cash profits are the cash a company generates from its operations. Capex is the cash needed to maintain equipment and invest in new buildings, equipment, etc.)

You can't fake cash... It's the one number on the financial statement that doesn't lie. This means free cash flow is an ideal way to measure profitability.

For every $1 that McDonald's makes, $0.22 goes straight to free cash flow. Most companies are lucky if their FCF is more than 10% of their total revenue.

With so much FCF, McDonald's loves to reward its shareholders...

Last year, the company paid out more than $3 billion in dividends to shareholders... And it bought back $4 billion in stock. Over the past five years, McDonald's shares outstanding have fallen by almost 25%.

Those are outstanding numbers.

As for McDonald's recent price action, the stock is moving in the right direction. Shares are up 23% over the past year and are currently hanging around all-time highs.

And if you want to see how McDonald's stock performs in tough times for the broader market, just look at the fourth quarter of last year:

From September 21 to December 24, the S&P 500 Index fell 19.75%. Over the same period, McDonald's shares actually rose... legging out a 3% gain.

Companies like McDonald's are exceptional.

These businesses generate consistent earnings and high returns on assets due to their powerful brands. When you see these qualities in a company, you know you've found a true capital-efficient company.

Even in a bear market, these are stocks you can hold on to forever.

Sometimes investing is simple. 

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