Better Buy: McDonald's Corp. vs. Starbucks

By Dan Caplinger Markets Fool.com

Competition within the restaurant world often comes from unexpected quarters. One might think that the clientele that fast-food giant McDonald's (NYSE: MCD) serves would be far different from the coffee-guzzling customers that Starbucks (NASDAQ: SBUX) woos. But over time, both companies have moved into each other's territory, with McDonald's offering its McCafe drinks while Starbucks aims at delivering breakfast and other food options. Many investors see both companies as having considerable strengths and want to know which one is the more promising stock right now. Let's look at how McDonald's and Starbucks compare on some key metrics to see which one might be a smarter pick for investors.

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Image source: Starbucks.

Valuation and stock performance

Neither Starbucks nor McDonald's has blown out the stock market in terms of performance, but the fast-food company has a clear lead. Starbucks is roughly flat since December 2015, but McDonald's is up about 8% over the same time period.

Even though the two stocks haven't climbed very far over the past year, both have valuations that are somewhat high. Looking at simple valuation methods based on trailing earnings, McDonald's current stock price works out to an earnings multiple of about 23. That's higher than the broader market. Starbucks gets an even bigger premium to the market earnings multiple than McDonald's, with its stock trading at 31 times trailing earnings. Those levels have fallen slightly during 2016, but they still point to the premium that investors are putting on their performance.

Valuations look a little more attractive when you incorporate future earnings projections. Starbucks carries a forward earnings multiple of 24, while McDonald's trades at roughly 20 times forward earnings. Both are somewhat expensive, but McDonald's offers a slightly better value in terms of simple valuation.

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Dividends

McDonald's also looks more attractive from a dividend standpoint. The fast-food giant's current dividend yield is 3.1%, and that compares extremely favorably with the 1.7% yield that Starbucks offers right now.

McDonald's has a long history of returning money to shareholders through dividends. You'll find the company on the list of elite Dividend Aristocrats, thanks to its 41-year history of consecutive annual dividend increases. The most recent raise came just last month, with a 6% boost taking McDonald's quarterly payout to $0.94 per share. Starbucks, by contrast, has only a seven-year streak of rising payouts, but it has been more aggressive in its recent growth, pushing its quarterly payout up by 25% last month to $0.25 per share. For now, that gives McDonald's the proven edge in terms of shareholder friendliness in its dividend policy.

Growth prospects and risks

Given the advantages that McDonald's has shown in valuation and dividends, Starbucks needs to distinguish itself on the growth front. Yet McDonald's has worked hard to foster rising sales, with the decision to serve breakfast all day having proven to be a popular choice that gets more customers in the doors and spending more when they do. After several years of sluggishness, McDonald's has returned to a sustainable growth trajectory. The fast-food company's most recent results showed a 3.5% rise in sales globally, and that helped boost its bottom line by nearly a tenth. McDonald's is also learning from its peers in the restaurant space, looking toward offering a wider array of food offerings and automating certain work functions to improve efficiency. The company has put together more than a year's worth of rising comparable restaurant sales, and that bodes well for its future.

Meanwhile, Starbucks is going through a transformation, with CEO Howard Schultz deciding to give up his leadership role next year. The coffee giant's five-year plan includes double-digit percentage growth projections for sales and earnings per share, with a rising presence in China playing a key role in driving expansion. Perhaps most interesting is the opportunity that Starbucks sees in the ultra-premium space, with its Reserve Roastery concept potentially appealing to high-end customers wanting a luxury experience while also promoting innovation that could filter down to Starbucks' conventional stores. Combine that with opportunities for greater penetration in grocery-sold consumer products, and Starbucks' growth prospects look very promising.

Both McDonald's and Starbucks have points in their favor. For high-growth investors, Starbucks' opportunity looks bigger than McDonald's. Yet with better value, solid dividend income, and reasonable chances for long-term growth, McDonald's will appeal to many value and income investors who appreciate the heritage that the fast-food giant brings to the table.

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Dan Caplinger owns shares of Starbucks. The Motley Fool owns shares of and recommends Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.