Two Underlying Factors You Need to Consider Before Buying Stocks

When many investors think of blue chip stocks, a common name that pops up is McDonalds Corporation (NYSE/MCD). 

A blue chip stock is traditionally a well-established company generating stable corporate earnings and usually paying out an attractive dividend yield. McDonald’s certainly hits the bull’s-eye on these blue chip metrics, which is especially attractive in today’s low-interest-rates world with its forward dividend yield of approximately 3.3%. 

The real question to ask is what is McDonald’s potential for corporate earnings growth over the next few years? 

There are two underlying factors that I would like to bring to your attention for consideration: 1) the financial health of the company’s primary customers, and 2) the cost of inputs.

While McDonald’s may keep its blue chip status, the growth of corporate earnings remains in doubt. As we all know, both the U.S. and global economy are becoming increasingly split between higher income and lower income people. As we know, neither the U.S. nor the global economy is firing on all cylinders, as seen by the still significantly high unemployment levels. 

Wages remain stagnant, and while companies can increase corporate earnings through share buybacks, at some point, revenues must accelerate. 

The problem for McDonald’s that could really impact corporate earnings growth is that the costs of inputs, specifically for beef, are rising substantially. The price of beef in February had the largest monthly increase since November of 2003. (Source: “CPI – Item Beef,” United States Department of Labor web site, last accessed March 19, 2014.) 

McDonald’s is already struggling with its one-dollar menu. The company has begun shifting its marketing strategy away from the “McDouble” cheeseburger to a new burger with just one beef patty, due to the rising beef costs. In fact, many McDonald’s franchisees have moved the price of the McDouble above its intended one-dollar price point, hoping to recoup losses from the higher costs. 

 

      Chart courtesy of www.StockCharts.com

While this is just one factor, as an investor in blue chip stocks, it should be a consideration. We know that many Americans in the lower income bracket (who are key consumers for the fast food giant) are struggling; can McDonald’s push through higher prices to continue increasing corporate earnings? I think there is a definite limit to what the typical McDonald’s consumer will spend, and corporate earnings growth is not assured over the next few years. 

This is not to say that McDonald’s will do anything drastic, such as cutting its dividend yield, but if you are focused on capital appreciation, you do need to be worried that the company is being squeezed by higher input costs and a lack of ability to raise prices to customers. 

In comparison, I think this is why a stock such as Tiffany & Co. (NYSE/TIF) continues to outperform, since its primary customer is experiencing an increase in wealth and is beginning to spend. Corporate profits are also rising since many of Tiffany’s costs are from precious metals, which have dropped in price over the past year. This is a favorable scenario for corporate earnings growth—a customer who is becoming wealthier and input costs that are not rising substantially. 

When it comes to investing in blue chip stocks, make sure you know what your real goal is and your risk tolerance. Don’t simply assume or extrapolate what we’ve seen over the past couple of years will continue forever. 

McDonald’s has had a very strong move over the past decade, much better than many other blue chip stocks, and I would certainly look to take some profits ahead of potential corporate earnings headwinds and move into areas that offer greater possibilities for growth. 

This article Two Underlying Factors You Need to Consider Before Buying Stocks was originally published at Daily Gains Letter