Valuation multiples help investors make investment decisions and are driven by the willingness to pay for a stock, growth prospects, risks, and uncertainties.
Of the available valuation multiples, we’ll be considering 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 earnings estimates for the next four quarters.
MCD’s PE multiple
The strong earnings and better-than-expected SSSG (same-store sales growth) in 1Q17 appear to have increased investor confidence, leading to a rise in McDonald’s stock price and in its PE multiple. As of April 26, 2017, McDonald’s was trading at PE multiple of 21.9x, as compared to 21.3x before the announcement of its 1Q17 earnings.
McDonald’s is trading at a PE multiple below the level of its major peers. But as a mature company, McDonald’s has a lower scope of expansion, which helps explain the lower multiple.
To enhance the customer experience, MCD plans to implement a mobile order and pay platform in 20,000 of its restaurants and to have 2,500 EOTF (Experience of the Future) restaurants by the end of 2017. These initiatives are expected to increase the company’s capital expenditure, and so if the initiatives fail to generate the expected sales, the increased expenses will likely put serious pressure on the company’s margins, lowering its earnings.
For the next four quarters, analysts are expecting McDonald’s to post EPS growth of 7.4%, which could have been factored into the company’s current stock price. If the company posts earnings lower than expected, selling pressure could lower the company’s PE multiple.
In the next and final part, we’ll look at the analysts’ recommendations for McDonald’s.