Investors should look at valuation multiples when deciding whether to enter or exit a stock. Valuation multiples are driven by perceived growth, risk and uncertainties, and investors’ willingness to pay for a stock. There are various multiples used to evaluate a stock. In this article, we’ll use the PE (price-to-earnings) ratio due to its high visibility in McDonald’s (MCD) earnings. The forward PE ratio is calculated by dividing the current share price by the forecasted earnings per share for the next 12 months.
McDonald’s PE multiple
The lower-than-expected same-store sales growth posted by the company in 2Q16 and deceleration in same-store sales growth of the burger industry has made investors skeptical about McDonald’s future earnings. This has led to a decline in McDonald’s share price and PE multiple. Since the announcement of 2Q16 results, McDonald’s share price has declined by 6%, and its PE multiple has declined from 21.8x to 20.6x. During the same period, McDonald’s peers Wendy’s Company (WEN), Restaurant Brands International (QSR), and Jack in the Box (JACK) were trading at 25.1x, 29.3x, and 20.7x, respectively.
Due to its lower growth rate, McDonald’s has been trading below its peers’ median value. However, since the reorganization strategy adopted in July 2015, the gap between McDonald’s PE multiple and its peers’ median has reduced.
Risks and uncertainties
To improve its same-store sales growth, McDonald’s is expanding its all-day breakfast menu items. Also, the company is reimaging its restaurants under its “Experience of the Future” initiative to enhance customer experience at its restaurants. It will be interesting to see the effect of these initiatives on same-store sales growth. If these initiatives fail to generate expected same-store sales growth, they can affect the operating margins of the company.
Analysts are expecting the company to post EPS of $5.8 in the next four quarters, which represents growth of 6.8% year-over-year. The current share price could have factored in these growth rates. If the company’s results come in lower, the stock could face selling pressure. That could bring the PE ratio down, and vice versa.
In the final part of this series, we’ll look at what analysts are recommending for McDonald’s.