When is it okay to pay an all-time high price for a stock
you'd like to own?
It's a question that's been nagging at me for the past couple
weeks - when I noticed that a whole slew of fast food restaurants
were hitting record high prices…
American's love for fast food doesn't appear to be ending
anytime soon - despite a trend towards healthier and more natural
But nothing really explains the number of fast food stocks
with not just high prices - but ridiculous valuations.
A couple weeks ago, I told you about
The Billion Dollar Noodle Shop
Noodles & Co. (
trading at 100x earnings.
But there are many others commanding juicy valuations.
There is the chicken franchise
Buffalo Wild Wings (
at 27x earnings and burrito shop
at 38x earnings. Now, these valuations aren't ridiculous. But
they're a good 50 - 100% above the average S&P 500 stock
When I see a sector that trades at a premium valuation, I want
. What justifies that rich price tag?
We know that investors pay more for growing companies.
So it stands to reason that high growth restaurant chains would
command a premium valuation. That's simply because
investors will pay a higher price today for bigger profits in the
But perhaps the biggest reason that investors will pay premium
prices for small restaurants is due to their
. There is a strong desire to invest in the next
stocks that have been amazing long-term investments for those who
got in on the ground floor.
My cardinal rule for buying any stock is to purchase only when
I see an attractive value.
In some ways, it's easiest to think about value in the
simplest of terms. Let's assume that you're filthy rich and
you've been approached by an investment banker. He suggests that
you buy Noodles & Co - the entire company - at its current
$1.2 billion dollar valuation.
Based on current earnings, you'd wait 100 years to earn back
your entire investment. Would you be willing to wait that
To give you a point of reference, if you were to buy a local
restaurant in your town, you might pay between 4 - 6x the
Of course the reason for that premium valuation is that
investors think Noodles & Co. will grow. And those
earnings could grow too.
When buying a company at such a rich valuation, I know that it
will have to grow like a weed for the next decade or two in order
to justify a premium price. That's a big risk, but it isn't the
If there is even the slightest misstep or financial shortfall,
bullish growth investors will rush to the sidelines. When that
happens, shares of a stock can drop 20 - 30% in a single day. And
that creates significant volatility.
Don't get me wrong. I'm not pessimistic on the entire
My favorite play is one of the biggest restaurants -
McDonalds. I recommended the stock to my
High Yield Wealth
subscribers in early 2011 when shares traded at $75.
Since then, the stock has risen 29% to $97. Plus the company
paid nearly $8 in dividends.
One of the reasons I love McDonalds is because the stock is a
dividend grower. It's increased its dividend in each of the
last 35 years, including a 26% jump in just the past 18
months. And my current yield - based on the $75 purchase
price - is at 4.1%.
The dividend growth and yield is crucial for income investors.
But the most important thing to consider is the valuation. Shares
are up considerably, but remain reasonably priced at 17x
earnings. That valuation is in-line with the stock's historic
valuation, and the stock market's average long term
McDonalds may not have the same
as Noodles & Co. or other richly priced restaurant
stocks. But the company's commitment to shareholders,
consistent dividend growth, and reasonable valuation still make
this stock a great long-term investment.
After disappointing earnings yesterday, McDonalds shares are
off 6% from their all-time high of $103. While most investors
wish they had bought the stock years ago, the recent pullback may
be a good short-term buying opportunity.
I've learned over the years that usually it's best to just buy
a great company like McDonalds, rather than trying to find the