Analyzing McDonald’s Valuation Multiple

Of the available valuation multiples, we considered the forward PE (price-to-earnings) multiple due to high visibility in McDonald’s (MCD) earnings. The forward PE multiple is calculated by dividing McDonald’s current share price with analysts’ earnings estimates for four quarters.

Better-than-expected 1Q17 earnings and initiatives were taken by McDonald’s management to drive its sales. Investors’ increased confidence led to a rise in its stock price and PE multiple. As of May 24, 2017, McDonald’s was trading at a PE multiple of 22.6x—compared to 21.3x before the announcement of its 1Q17 earnings.

On the same day, its peers Wendy’s (WEN), Jack in the Box (JACK), and Restaurants Brands International (QSR) were trading at PE multiples of 32.4x, 21.0x, and 29.0x, respectively. As a mature company, McDonald’s has less scope of expansion, which led the company to trade at a lower multiple than its peers’ median value.

McDonald’s has been planning to build 2,500 EOTF (Experience of the Future) restaurants and implement a mobile order and pay platform in 20,000 of its restaurants by the end of 2017. The initiatives are expected to increase the company’s expenses. If the initiatives don’t generate expected sales, the increased expenditure could put pressure on McDonald’s margins and lower its earnings.

For the next four quarters, analysts expect McDonald’s to post EPS growth of 8.0%, which could have been factored into its current stock price. If the company posts earnings that are lower than analysts’ expectations, the selling pressure could lower the company’s stock price and its PE multiple.

You can mitigate these risks by investing in the iShares US Consumer Services ETF (IYC). IYC has invested 10.9% of its holding in restaurants and travel companies.