(Note: The author of this fundamental analysis is a financial writer and portfolio manager.)

McDonald's Corp. (MCD) shares fell about 3 percent on September 12, after recently reaching an all-time high. According to a story on Bloomberg, research firm M-Science said sales projections for the hamburger chain are tracking below Wall Street estimates and could fall short of expectations. The recent hurricanes are being blamed for the sales weakness.

In an August 3 Investopedia article, we noted that McDonald's stock could fall by nearly 20 percent from its current levels of around $155. Since then, shares have been flat. (See also: Why McDonald’s Shares Could Fall 20%.)

But McDonald's valuation has remained elevated while investors should be thinking about how McDonald's can continue to grow earnings if revenue is expected to continue to decline.

Expensive Shares

Shares of McDonald's are still not cheap. The stock is trading at very stretched levels on a historical standard, with a one-year forward P/E ratio at roughly 22.5, while price-to-cash flow is also trading at nearly 18. It makes you wonder why the stock continues to trade at such stretched valuations.

Revenue estimates have started rising for 2017, 2018, and 2019, but are still projected to decline in all three years. On the surface, it suggests that the business will continue to be under stress, and that any EPS gains will have to come through cost cuts or share repurchases. The company will need EPS to grow to justify the current multiples of the stock.

Cutting Cost

According to Sentieo, analysts estimate that earnings before interest and taxes (EBIT) will rise to $9.5 billion by 2019, an increase of $1.6 billion since 2016. This suggests decreasing expenses are fueling McDonald's bottom-line growth. That is because top-line revenue is expected to decline to $19.5 billion in 2019, or approximately $5 billion from 2016's full-year reading. There is surely plenty of cost-cutting that is likely taking place to make up for that much of a revenue decline, while still being able to grow EBIT.

Longer-Term Problems

In the shorter-term, cutting costs to boost earnings seems like a good solution to a growth problem, but over the longer-term, it is not an ideal solution. There are only so many expenses to cut. And with revenue falling for many years and projected to continue to decline, what happens when all the cost-cutting is done? Where will the earnings growth emerge from? This is worth thinking about because investors today are paying record high multiples for a stock that is expected to have a declining revenue stream for some time to come.

It would be hard to say McDonald's shares were overvalued if it were trading within a normal historical range, but it is not. It is expensive no matter how one tries to analyze the shares. Should earnings growth stop, the larger fundamental problem will then emerge.

Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.

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