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McDonald’s remains a strong long-term play

Universal Press Syndicate

McDonald’s (NYSE: MCD) recently delivered appetizing quarterly results, despite the ugly economic environment. First-quarter net income increased 3.5 percent to $979.5 million, while sales dropped 9.5 percent, to $5.08 billion. (Excluding currency conversion, sales would have risen 2 percent.)

Proving its continued popularity with consumers, McDonald’s’ “same-store” sales (for units open a year or longer) rose 4.3 percent overall, 4.7 percent in the U.S., 5.5 percent in the Asia/Pacific, Middle East and Africa segment, and 3.2 percent in Europe.

McDonald’s has been known as a winner in the current economic environment, as consumers reduce their spending. Its search for deals hasn’t made life easier for other discounters, though. Burger King recently disclosed a drop in traffic in its fiscal third quarter, with same-store sales rising only 1 percent.

Shares of the Golden Arches were recently trading with a price-to-earnings (P/E) ratio of around 14 – in line with Burger King, yet cheaper than Yum Brands’ 18. It doesn’t seem dirt cheap, but its continued solid performance and the fact that it’s a steady dividend payer (with a yield recently north of 3.5 percent) make for a strong investment thesis right now.

Ask the Fool

Q: What’s the difference between intrinsic value and market value? – C.B., Farmington, N.M.

A: That’s a critical concept for investors to understand. Imagine Acme Explosives Co. (ticker: KBOOM). Its intrinsic value is what it’s really worth, based on its assets and debt, its anticipated growth rate and, ultimately, the amount of cash it’s expected to generate over its lifetime. Unfortunately, that’s not easy to determine, and different analysts will arrive at different numbers. Plus, things change. Acme’s intrinsic value may be estimated around $5 billion. But if a competitor introduces a better explosive, Acme’s future, and therefore its intrinsic value, is suddenly different.

Meanwhile, market value is what investors are willing to pay for a company. It’s typically measured by calculating a company’s “market capitalization.” If Acme Explosives has 200 million shares outstanding and the current share price is $30, then its market cap is $6 billion (200 million times $30 is $6 billion). If a firm’s intrinsic value is higher than its market value, then its stock is undervalued and attractive.

Q: Must I sell my IRA stocks when I turn 70 1/2 ? – E.M., Tallahassee, Fla.

A: With traditional IRAs, you must begin taking distributions after you turn 70 1/2 (though due to our economic crisis, Congress is permitting us to forgo that in 2009). Your withdrawals generally will be taxable. You may need to sell some stocks in the IRA to generate the cash (though some IRAs permit distributions of shares rather than cash).

If you have a Roth IRA, there are no mandatory distributions. And if the Roth IRA is at least 5 years old and you’re older than 59 1/2 , distributions are tax-free. Learn much more about IRAs at www.fool.com/ira.

Fool’s school

The task of finding good companies to invest in all comes down to two questions:

(1) Is this a strong, high-quality company?

(2) Is the company’s stock priced attractively right now?

If you don’t address both questions, you might end up buying grossly overvalued shares of a wonderful company, or you might snap up shares of a hapless, doomed business at what seems like a bargain price. Investors have lost big bundles doing either or both of those things.

The first question is much easier to answer than the second. An enterprise such as Nike, McDonald’s or ConocoPhillips might quickly appear to be a first-rate firm. But at what price is it a good buy?

Some investors believe that as long as you’ve got a great company, the price isn’t that important. They figure if an overvalued company keeps growing, it’ll eventually grow into and surpass its price. (This can happen, but it might take a long time, and sometimes it doesn’t happen. Also, the average growth rate over time might not be that impressive.) Most successful investors recognize that buying at an attractive price is vital to reduce risk and maximize gain.

Conveniently, most company evaluation measures are related to either quality or price. Quality-related measures reflect a firm’s profitability, growth and health. They include sales and earnings growth rates, profit margins, return on equity (ROE), return on assets (ROA), inventory turnover, market share and management quality, among other things.

Price-related measures help you determine whether the stock is overpriced, underpriced or priced just right.

They address a company’s valuation or stock price, and include its market capitalization, enterprise value, P/E ratio and price-to-sales ratio.

My dumbest investment

In 2004, a friend told me about a broadband provider that was soon going to go public (via an initial public offering, or IPO) for $1 per share. I bought more than 1,000 shares. The stock tripled, and my friend advised me to sell. But I thought, “We have a rising stock market and surely the stock will go even higher.”

Well, the stock plummeted to less than 10 cents per share, where it rested for almost a year. The company then changed its name, but its value remained the same.

Lesson learned: Don’t buy stock for less than $5 per share. – Mike W., via e-mail

The Fool Responds: First, you’re right to avoid “penny stocks,” as they can be easily manipulated and hyped. They can be very volatile and are often tied to companies without strong track records of growth and earnings.

Be wary of IPOs, too. It’s hard for us little investors to get in early on the good ones, and in many cases, you can do better by waiting a year or two, until the stock settles down.

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