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Why McDonald’s Valuation Multiple Declined after 4Q17 Earnings

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Valuation multiple

Valuation multiples help investors compare companies with similar business models. For our analysis, we’ve opted for the forward PE (price-to-earnings) multiple due to the high visibility of McDonald’s (MCD) earnings. The forward PE multiple can be calculated by dividing the company’s current stock price from analysts’ earnings estimate for the next four quarters.

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MCD’s forward PE multiple

Although McDonald’s has outperformed analysts’ SSSG (same-store sales growth), revenue, and EPS (earnings per share) estimates, its stock price fell due to fear of customers trading down to cheaper menu options with the introduction of a new $1 $2 $3 Dollar Menu. The fall in the stock price led McDonald’s forward PE multiple to decline to 23.2x on January 30, compared to 24.3x before the announcement of 4Q17 earnings.

From the graph above, we can see that McDonald’s valuation multiple has increased since the beginning of 2017. The better-than-expected earnings in first three quarters of 2017, and measures undertaken by the company’s management, have increased investors’ confidence, leading to a rise in the company’s stock price and valuation multiple.

On the same day, McDonald’s peers Starbucks (SBUX), Wendy’s (WEN), and Jack in the Box (JACK) were trading at forward PE multiples of 22.2x, 27.5x, and 19.1x, respectively.

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Growth prospects

To drive its SSSG, McDonald’s has been focusing on remolding its restaurants to EOTF (experience of the future), expanding its delivery service, and implementing mobile order and pay facilities to more restaurants. All these initiatives are expected to increase the company’s expenditure. If these efforts fail to generate expected sales, the increased expense could pressure McDonald’s future earnings.

For the next four quarters, analysts expect McDonald’s to post EPS growth of 12.4%, which could have been factored into the company’s current stock price. If the company posts earnings lower than analysts’ estimates, the selling pressure could bring the company’s stock price and valuation multiple down.

Next in this series, we’ll look at analysts’ recommendations.

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