U.S. Markets closed

Better Buy: PepsiCo vs. McDonald's

John Ballard, The Motley Fool

PepsiCo (NASDAQ: PEP) and McDonald's (NYSE: MCD) are two of the most recognized brands in the world. These companies are long past their glory days of fast growth, but each stock is valued by investors for its dependability when the economy hits a rough patch and for its steady stream of dividend payments.

In addition to its roster of top soda brands, Pepsi also owns several household names in snack food, including Doritos and Tostitos, in addition to healthier fare like Quaker Oats and Aquafina water. 

McDonald's has gone through a significant transformation in the last few years. Restaurants are getting modernized, customers can order through mobile apps, and while management has made a greater commitment to quality ingredients and healthier menu choices, there are still a lot of Quarter Pounders sold every year.

Both companies are undergoing massive changes to improve operating performance to deliver better returns to investors, but only one can be the better buy. We'll compare both companies on current growth, valuation, and dividends to find out which one is the better investment today.

A cheeseburger, soft drink, and a bag of french fries lying on a table.

IMAGE SOURCE: GETTY IMAGES.

Which company is growing faster?

Both companies have had their challenges dealing with shifting consumer preferences in recent years. Various surveys show that more consumers are watching their sugar intake and are scrutinizing the quality of their food. However, one trend is certainly benefiting McDonald's, and that is more consumers choosing to eat out more often. 

Pepsi's latest quarter showed management's plan to improve brand messaging and deliver new products to drive faster top-line growth is starting to show results. Organic revenue increased by 4.8% year to date, but investments to improve the supply chain and other areas of the company have weighed on the bottom line. As a result, adjusted earnings per share (EPS) dipped 2% year over year in the second quarter. 

On the other side, McDonald's is on a roll. The new Experience of the Future restaurant format, which has been implemented at 8,500 locations so far, is having a tremendous impact on customer satisfaction and operating performance. In the second quarter, comparable-store sales increased by 6.5% -- the best in four years -- while EPS grew 7% year over year. 

McDonald's has better growth prospects

Pepsi is targeting growth of 4% to 6% in adjusted revenue over the long term. The beverage giant is still working to get the wheels cranking a little faster. It's investing in faster-growing markets, such as energy drinks and natural food, and it acquired SodaStream last year. However, McDonald's is already growing faster and has many opportunities it has yet to capture that could keep driving fast growth.

The Golden Arches is still rolling out its Experience of the Future store concept around the world, as well as investing in digital ordering and delivery. 

Most importantly, unlike Pepsi, McDonald's has shown it doesn't need to acquire other companies to find growth. McDonald's sold more than 55 million more Quarter Pounders in the first half of 2019 compared to last year, which management attributed to new variations of the classic menu item and the modernized restaurants.

Valuation

So far, McDonald's looks like the better choice for investors. But before we declare the winner, let's check the valuation.

McDonald's trades at a higher forward price-to-earnings (P/E) ratio of 27 based on this year's earnings estimate. On the other side, Pepsi stock sells for 23 times forward earnings estimates. The difference reflects McDonald's faster rate of growth, so I wouldn't call its higher valuation a negative.

Looking ahead to 2020, analysts expect Pepsi to grow adjusted earnings by 8.1% next year, but McDonald's is expected to grow profits somewhat faster at 9.1%. Analysts also expect McDonald's to maintain faster earnings growth over the next five years. 

Dividends

Many investors like investing in consumer goods giants for the dividends, so here's how both stocks stack up:

Metric PepsiCo McDonald's
Dividend yield 2.90% 2.05%
Cash payout ratio 84.67% 65.71%
Forward P/E 23.35 27.29

Data source: YCharts.

Pepsi has a higher yield, but that's because it pays out a higher percentage of free cash flow as dividends, so we can't call a higher yield an advantage here. 

Still, some investors may prefer Pepsi for the lower valuation and higher dividend yield. I believe both companies have durable competitive advantages based on their brand power and global reach, so investors likely can't go wrong investing in either for the long haul.

Both stocks look expensive 

To be honest, neither company appears to be growing earnings fast enough to justify its price tag. But if I had to choose one, I would lean toward the one that is showing better strength in the marketplace, as shown by faster growth in sales and profits. Therefore, I believe McDonald's is the better buy.


John Ballard has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com