Due to the high visibility of McDonald’s (MCD) earnings, we’ve opted for a forward PE (price-to-earnings) multiple for our analysis. A forward PE multiple is calculated by dividing the company’s stock price from analysts’ earnings estimate for the next four quarters.
Forward PE multiple
McDonald’s better-than-expected 3Q17 SSSG (same-store sales growth) and measures adopted by the company’s management to improve its sales appear to have increased investor confidence, leading to a rise in the stock and a rise in the valuation multiple. As of October 25, 2017, McDonald’s was trading at a forward PE multiple of 23.66x compared to 23.57x before the announcement of its 3Q17 earnings.
In the above graph, we can see that McDonald’s is trading below the peer median. Since McDonald’s is in the mature stage of its business cycle, it has a lesser scope to expand its business, which has led the company to trade at a lower forward PE multiple. On the same day, its peers Jack in the Box (JACK), Wendy’s (WEN), and Restaurant Brands International (QSR) were trading at forward PE multiples of 21.17x, 27.52x, and 27.76x, respectively.
McDonald’s management has been focusing on implementing technological advancements such as EOTF (Experience of the Future) and expanding mobile order pay facilities to more of its restaurants to improve SSSG. The company is also partnering with UberEATS to expand its delivery services to 5,000 restaurants by the end of 2017. All these initiatives are expected to raise McDonald’s expenses. If the initiatives fail to generate expected sales, the increased expenditure could put pressure on the company’s earnings.
For the next four quarters, analysts are expecting McDonald’s EPS (earnings per share) to rise 6.3%. If the company fails to generate expected sales, selling pressure is expected to bring down the company’s stock and valuation multiple.
Next, let’s take a look at McDonald’s target price.