Is McDonald’s Stock a Buy?

It’s not difficult to come up with several reasons to steer clear of a stake in fast-food chain McDonald’s. Many franchisees are voicing frustration with their ever-increasing spending requirements, especially in light of the current push for a $15-per-hour minimum wage in the U.S. Then there’s the not-so-small fact that the fast-food business is incredibly competitive and seemingly saturated. In the United States alone, there are nearly 200,000 such restaurants. Throw in the renewed interest in healthier diets, and it just feels as if McDonald’s faces one too many challenges.

McDonald’s is still a buy, however, because one single, simple edge easily overrides all of its vulnerabilities: being the most recognizable brand name in the industry.

A name everyone knows and loves

The Golden Arches feature prominently in 39,198 restaurants all over the world, 93% of which are franchisee-owned. That’s second only to Subway’s 42,000 stores, although the former company does decidedly more business. McDonald’s restaurants collectively generate sales on the order of $100 billion per year (in a normal year). No other restaurant company comes close, in terms of geographic reach or total sales. Indeed, no other restaurant chain is even getting a chance to try to catch up, unable to cut through the dominance McDonald’s enjoys.

This dynamic raises a philosophical question: Is McDonald’s big because it’s good, or good because it’s big? The answer is, probably a little of both. Leading the market, McDonald’s has the size and cash hoard needed to maintain its lead on what’s arguably the most important front in the industry. Its brand name and logo are not only universally recognized but also well-loved.

IG Markets Limited quantified the idea early last year, determining that McDonald’s is the world’s ninth most recognized brand. That’s one notch better than 10th-place Walt Disney, jibing with similar studies from Appy Pie and BrandZ, the latter of which rates McDonald’s the ninth most valuable brand in the world, right behind Facebook.

Given how there’s nothing special about a hamburger, the fact that McDonald’s is rubbing elbows with outfits like Facebook and Disney speaks volumes.

The right name changes everything

The upside of this brand recognition and respect is twofold. First, it drives consumer loyalty.

In the same sense that it’s not clear whether the restaurant chain is good or just big or a bit of both, it’s not completely clear if consumers visit a McDonald’s because it’s their first choice, or because it’s the most accessible option. But the reason doesn’t entirely matter, as going to McDonald’s is a habit. Nearly 70 million people visit one of its stores every day, where they’re greeted with a deliberately designed color scheme and environment meant to keep those consumers coming back. Red, as it turns out, sparks hunger in addition to getting your attention, while yellow evokes a feeling of friendliness. If you see those Golden Arches on top of the red banner enough times right before you drive into a McDonald’s parking lot, eventually your brain makes a powerful connection between the logo and a cured craving.

This sets the stage for the second upside of this strong brand-recognition factor: As much as franchisees might lament rising fees and required investments in real estate that’s actually owned by the company — not the proprietor — there’s no other restaurant name as reliable or as profitable for the franchisee.

Some franchisee numbers to consider: While the average cost of establishing a new store can cost between $1 million and $2 million, the average store reportedly does on the order of $2.7 million worth of business every year. Of that top-line average revenue, about $150,000 is turned into a profit for the franchisee, although some stores clear considerably more. It would be difficult for a fast-food restaurant operator to produce similar income under another banner. For perspective, comparative figures for Wendy’s (NASDAQ:WEN) are roughly two-thirds that of the top and bottom lines at McDonald’s stores.

As long as this remains the case, McDonald’s will continue to attract and retain the best talent in the industry.

Bottom line

None of this is to suggest McDonald’s is bulletproof. It’s not. Things can go wrong, and while it’s prompted little more than grumbling to date, the latest round of fee increases imposed late last year exposed just how tenuous the company’s relationship with franchisees still is. It’s something to watch for sure.

For investors, though, paying a premium price for a “best-of-breed” pick typically pays for itself. These companies are the top names in their industry for a reason, and McDonald’s is no exception. And this is what makes McDonald’s stock worth owning.