The below table provides some of McDonald’s financial data for 2008 and 2015. Here are two stories about that data.

McDonald’s Financial Data, 2008 vs. 2015

2008 Change 2015
($ in billions) ($ in billions)
Revenue $23.522      7.98% $25.413
Net Income   $4.313      5.01% $4.529
Long Term Debt $10.186    76.61% $17.990*
Net Property & Equipment $20.254    14.74% $23.239*
Equity $13.382   (37.9)%   $8.309*
Weighted Average Shares    1.146 (17.27)%   0.948
P/E ratio  16.94x
(as of 12/31/2008, on 2008 EPS)
(on 2015 EPS)

*as of September 30, 2015
Source: Sec filings, Company press release

One Story: The business of McDonald’s during those 7 years, as measured by its revenues, rose by less than 1% per year, 7.98% in all. Its net income rose by even less. Its balance sheet was more dynamic: the company did invest in new property and equipment, which increased by almost 15%, but long-term debt rose by over 75%. Its shareholders’ equity contracted by almost 38%. If you could have been told this story in 2008, would you have purchased the shares?

Another Story: The McDonald’s share price appreciated by 90% over the 7 years, which is an almost 10% annuallized return.

The Explanation: One thing that happened is that the McDonald’s P/E ratio expanded from 16.9x to 24.6x. That shareholders were willing to pay more for the same earnings accounted for about half of the stock return. Another thing that happened was that interest rates dropped; for 10-year Treasuries, for instance, from just over 4% in 2008 to less than 2% in 2015. This permitted McDonald’s to finance a massive share repurchase program that would otherwise not have been affordable but for these artificially low rates, which is why its interest expense only rose by 22% even as its debt ballooned. The company also increased its dividend by more than 100%, which was no doubt appreciated in a yield starved world.

Whether or not interest rates increase, it must surely be realized that the share price appreciation of the past seven years is highly unlikely in companies that continue to perform in this manner. The S&P 500 is replete with this type of corporate strategy, in which lower interest rates have played a significant role in valuation inflation.

In Summary: The careful measurement of the return and volatility characteristics of the “benchmark” (and its major constituents – such as McDonald’s), over which so much attention is paid and such enormous sums of money moved, is simply another way of looking at a central bank interest rate policy progression that can never be repeated.

– Adapted from The Contrarian Research Report Compendium – March 2016

A Word on Pension Plans:

A great many of the S&P 500 companies also have meaningful pension plans, in which lower rates would have played an even a larger role in the appreciation of the company’s stock by causing appreciation in the plan assets, especially the bond portfolio, and thereby limiting the contributions a company might have been forced to make to the plan. (That beneficial relationship might now work in the reverse, because if the bond portfolio earns a paltry rate of interest and the stock portfolio is overvalued, the plans are unlikely to earn their required return, and companies will have to make contributions, which will actually depress earnings.)

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Important Disclosures

Past performance is not indicative of future returns. This information should not be used as a general guide to investing or as a source of any specific investment recommendations. This is not an offer to sell or a solicitation to invest. Source information for quoted statistics is available upon request.

Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. Under no circumstances does the information contained within represent a recommendation to buy, hold or sell any security, and it should not be assumed that the securities transactions or holdings discussed were or will prove to be profitable. There are risks associated with purchasing and selling securities and options thereon, including the risk that you could lose money. Horizon Kinetics LLC is parent company to Horizon Asset Management LLC, Kinetics Asset Management LLC and Kinetics Advisers, LLC, all of which are investment advisers registered with the U.S. Securities and Exchange Commission and which may hold positions in certain of the securities or investment products referenced herein.

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