Valuation multiples help investors make investment decisions and are driven by perceived growth, investors’ willingness to pay for a stock, and risk and uncertainties.
Of the various available multiples, we’ll use the forward PE (price-to-earnings) multiple due to the high visibility of McDonald’s (MCD) earnings. The forward PE multiple is calculated by dividing the current stock price by the company’s earnings estimates for the next four quarters.
MCD’s PE multiple
MCD’s measures to improve its SSSG (same-store sales growth) and its expansion plan in China and Hong Kong appear to have increased investor confidence in the company, leading to a rise in McDonald’s stock price. As of April 19, 2017, McDonald’s was trading at a PE multiple of 21.1x, as compared to 19.9x before the announcement of its 4Q16 earnings.
In the above graph, we can see that McDonald’s PE multiple is lower that its peers’ median values. As a mature company, McDonald’s has a smaller scope for expansion, which has led the company to trade at a lower multiple.
For the next four quarters, analysts are expecting McDonald’s to post EPS growth of 7.5%. The company’s current price might have already been factored in this EPS growth, however. If the company posts lower EPS, then the selling pressure could push McDonald’s PE multiple down.
Remember, you can mitigate such company-specific risks by investing in ETFs like the iShares US Consumer Services (IYC). IYC has 11.6% of its holdings invested in restaurants and travel companies.
In the next and final part of this series, we’ll examine the Wall Street analysts’ recommendations and price targets for MCD.