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McDonald's: Investors Are Optimistic before Its 2Q17 Earnings

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Part 5
McDonald's: Investors Are Optimistic before Its 2Q17 Earnings PART 5 OF 6

McDonald’s Valuation Multiple Compared to Its Peers

Valuation multiple

We considered the forward PE (price-to-earnings) multiple for our analysis due to greater visibility in McDonald’s (MCD) earnings. The forward PE multiple is calculated by dividing the company’s stock price by analysts’ earnings estimate for the next four quarters.

McDonald&#8217;s Valuation Multiple Compared to Its Peers

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McDonald’s PE multiple

Better-than-expected 1Q17 earnings and management’s initiatives to enhance customers’ experience and improve the quality of menu items appear to have increased investors’ confidence, which led to a rise in McDonald’s stock price and its forward PE multiple. As of July 13, 2017, McDonald’s was trading at 23.4x—compared to 21.3x before the announcement of its 1Q17 earnings.

From the above graph, you can see that McDonald’s valuation multiple is trading below its peers’ median. Being a mature company, McDonald’s has less scope to expand, which caused the company to trade at a lower multiple than its peers. On the same day, Jack in the Box (JACK), Wendy’s (WEN), and Restaurant Brands International (QSR) were trading at 19.8x, 30.3x, and 28.4x, respectively.

Growth prospects

To enhance customers’ experience, McDonald’s plans to implement the mobile order and pay service in 20,000 restaurants by the end of 2017. The company plans to develop 2,500 “experience of the future” restaurants by the end of the year. These initiatives, along with measures to improve the quality of its menu items, are expected to increase McDonald’s expenses. If the initiatives don’t generate expected sales, the increased expenditure will put pressure on McDonald’s margins and lower its earnings.

For the next four quarters, analysts expect McDonald’s EPS to rise 8.5%, which could have been factored into its current stock price. If the company’s earnings are lower than analysts’ estimates, selling pressure could lower McDonald’s stock price and its forward PE multiple.

You can mitigate these company-specific risks by investing in the Consumer Discretionary Select Sector SPDR Fund (XLY). XLY has invested 12.1% of its holdings in restaurant and travel companies.

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