Behind the Valuation Multiples of Fast Food Restaurants

Valuation multiples help investors decide on entry and exit points in securities. A company’s valuation multiple is affected by its perceived growth, risks and uncertainties, and investors’ willingness to pay. Various multiples can be used to determine stocks’ valuations. For this analysis, we’ll be using PE (price-to-earnings) multiples given the high visibility of fast food companies’ earnings.

The forward PE ratio is calculated by dividing a company’s current share price with its forecasted EPS (earnings per share) for the next 12 months.

As of September 16, 2016, these five fast food restaurants were trading at a median PE multiple of 21.4x. With higher margins and an aggressive expansion policy, Restaurant Brands International (QSR) continues to trade at a higher multiple of 27.6x. 

Wendy’s (WEN) has a PE multiple of 27x. The company’s lower-than-expected 2Q16 results have led Wendy’s share price to fall in 2Q16, which has brought the PE multiple down from 29.4x.

Wendy’s is followed by Jack in the Box (JACK) with a PE multiple of 21.4x. At the beginning of 2Q16, JACK was trading at a PE multiple of 16.7x. Its better-than-expected 1Q16 and 2Q16 results have raised JACK’s share price by over 50%, which has led to a rise in JACK’s PE multiple. JACK is followed by McDonald’s (MCD) and Sonic (SONC) with PE multiples of 19.8x and 21.4x, respectively. The PE multiple of SONC has fallen from 24.8x, while MCD’s PE multiple has fallen from 22.8x. SONC’s stock price has fallen by over 26% since the beginning of 2Q16.

Investors can mitigate company-specific risks by investing in the Consumer Discretionary Select Sector SPDR Fund (XLY), which invested over 10% of its holdings in travel and restaurant companies.

In the next and final part, we’ll see what analysts are recommending for the five fast food restaurants after their 2Q16 results.