McDonald’s Corporation (NYSE:MCD) and The Wendy’s Company (NASDAQ:WEN) are the two most active stocks in the Restaurants industry based on today’s trading volumes. Investors are clearly interested in the two names, but is one a better choice than the other? We will compare the two companies across growth, profitability, risk, valuation, and insider trends to answer this question.
Companies that can increase earnings at a high compound rate over time are attractive to investors. Analysts expect MCD to grow earnings at a 10.27% annual rate over the next 5 years. Comparatively, WEN is expected to grow at a 16.65% annual rate. All else equal, WEN’s higher growth rate would imply a greater potential for capital appreciation.
Profitability and Returns
Growth isn’t very attractive to investors if companies are sacrificing profitability and shareholder returns to achieve that growth. We will use EBITDA margin and Return on Investment (ROI), which control for differences in capital structure between the two companies, to measure profitability and return. McDonald’s Corporation (MCD) has an EBITDA margin of 38.75%, compared to an EBITDA margin of 31.57% for The Wendy’s Company (WEN). This suggests that MCD underlying business is more profitable. MCD’s ROI is 23.40% while WEN has a ROI of 8.00%. The interpretation is that MCD’s business generates a higher return on investment than WEN’s.
The amount of free cash flow available to investors is ultimately what determines the value of a stock. MCD’s free cash flow (“FCF”) per share for the trailing twelve months was +0.10. Comparatively, WEN’s free cash flow per share was +0.19. On a percent-of-sales basis, MCD’s free cash flow was 0.33% while WEN converted 3.23% of its revenues into cash flow. This means that, for a given level of sales, WEN is able to generate more free cash flow for investors.
Liquidity and Financial Risk
Liquidity and leverage ratios provide insight into the financial health of a company, and allow investors to determine the likelihood that the company will be able to continue operating as a going concern. MCD has a current ratio of 2.10 compared to 1.90 for WEN. This means that MCD can more easily cover its most immediate liabilities over the next twelve months.
MCD trades at a forward P/E of 22.77, and a P/S of 5.35, compared to a forward P/E of 27.47, a P/B of 7.85, and a P/S of 2.98 for WEN. MCD is the cheaper of the two stocks on an earnings basis but is expensive in terms of P/B and P/S ratio. Given that earnings are what matter most to investors, analysts tend to place a greater weight on the P/E.
Analyst Price Targets and Opinions
A cheap stock is not necessarily a value stock. Most of the time, a stock is cheap for good reason. A stock only has value if the current price is substantially below the price at which it should trade in the future. MCD is currently priced at a -7.5% to its one-year price target of $171.68. Comparatively, WEN is -6.01% relative to its price target of $16.63. This suggests that MCD is the better investment over the next year.
The average investment recommendation on a scale of 1 to 5 (1 being a strong buy, 3 a hold, and 5 a sell) is 2.00 for MCD and 2.40 for WEN, which implies that analysts are more bullish on the outlook for WEN.
Risk and Volatility
Beta is a metric that investors frequently use to analyze a stock’s systematic risk. A beta above 1 implies above average market volatility. Conversely, a stock with a beta below 1 is seen as less risky than the overall market. MCD has a beta of 0.69 and WEN’s beta is 0.98. MCD’s shares are therefore the less volatile of the two stocks.
Insider Activity and Investor Sentiment
Short interest is another tool that analysts use to gauge investor sentiment. It represents the percentage of a stock’s tradable shares that are being shorted. MCD has a short ratio of 1.96 compared to a short interest of 5.21 for WEN. This implies that the market is currently less bearish on the outlook for MCD.
McDonald’s Corporation (NYSE:MCD) beats The Wendy’s Company (NASDAQ:WEN) on a total of 8 of the 12 factors compared between the two stocks. MCD is more profitable, generates a higher return on investment and higher liquidity. MCD is more undervalued relative to its price target. Finally, MCD has better sentiment signals based on short interest.