The company has been as steady as anyone could hope, but that doesn’t mean it’s always a good time to buy, especially if you’re just looking at price charts, observes Julie Carnevale of FASTgraphs.com.
After examining McDonalds’ (MCD) history over several different time frames, we learn that this company has a very consistent record of growing earnings at double-digit rates. Moreover, we also learned that “Mr. Market” has shown a penchant of pricing McDonalds’ shares within reasonable variations of its earnings achievements.
However, it’s now time to look to the future in order to answer the question posed by the title of this article: whether or not McDonalds is too rich to buy or hold at today’s prices.
So utilizing our Estimated Earnings and Return Calculator, let’s start by looking at our default estimates based on the current consensus of 19 analysts reporting to Capital IQ.
Here we discover two things that we believe are important. First of all, the consensus of leading analysts expects McDonalds’ earnings to only grow at a below historical average rate of 10% per annum over the next five years.
Moreover, the consensus for calendar year 2012 is for earnings to only grow at 9% before moving on to the average five-year growth estimate of 10%. Based on McDonalds’ past history, we feel it’s logical to assume that there might at least be a moderately negative bias to current estimates.
This seems even stranger when you consider that on January 24, McDonalds reported fourth-quarter 2011 earnings growth of approximately 15%, and the same number for all of calendar year 2011 (note that our graphs are only showing 2011 earnings growth of 14%, marked with an "E" for estimate, as the official data has not yet filtered through the database).
Assuming that consensus estimates are correct, it would appear that McDonalds’ shares are currently moderately overvalued (share price more than two years ahead of earnings—red line).
The four lighter colored orange lines, two above and two below the darker orange line, represent what we like to call the value corridor. Notice that the lines are all parallel to each other and sloped at the estimated growth rate of 10%.
Also, the appropriate P/E ratios that apply to each of the lines are listed on the scale to the right of the graph. Therefore, the calculated five-year estimated total return of 8.4% per annum assumes that McDonalds does in fact grow earnings at the consensus rate of 10%, and that the market appropriately capitalizes that growth at a P/E of 15.
However, when you consider that McDonalds has grown earnings at 15.7% since calendar year 2007, and that their earnings growth in 2011 was also 15%, the consensus estimate of only 10% seems low.
Therefore, utilizing the override feature of the Estimated Earnings and Return Calculator, we will recalculate our expectations for McDonalds’ five-year estimated future growth using their 15.7% historical average. In other words, we are asking “what if” McDonalds continues to grow earnings as it has in the past.
When we redraw the chart using these numbers, we discover that McDonalds may still currently be fully valued where its price is now sitting near the top of the value corridor (the top light orange line).
However, we believe it would be a stretch to call it overvalued at today’s price levels. Considering that if McDonalds was to continue achieving its historical growth, then the potential for a total annual return of approximately 15% or better becomes very real.
Unfortunately, most investors are forced to rely on charts based solely on stock price in order to determine whether the stock is a good buy, sell, or hold. Consequently, it’s very easy to become misled by either a rapidly rising or rapidly falling stock price.
We believe that the only way to really have a clear vision of the appropriateness of investing in any given stock is when price and fundamentals can be viewed simultaneously.
When you examine the 20-year earnings (fundamentals) and price correlated graph on McDonalds, the relationship between fundamentals and stock price can be vividly seen. Therefore, more appropriate buy, sell, or hold decisions can be made based on a sound foundation of fundamentals. This is not to imply that perfect decisions can be made, but we believe it is clear that when price and fundamentals are viewed in concert with each other, a more learned perspective is attained.
When applying these principles to McDonalds’ current valuation, it appears that McDonalds’ stock is currently fully priced…but once again, we would stop short of calling it overpriced. Although we would not purchase McDonalds’ stock at today’s prices, we only make that decision based on the belief that sometime in the near future we might be given the opportunity to invest in this blue-chip at a better valuation.
This opinion is founded upon the principles of valuing earnings, and the long-term history of how the market has specifically valued McDonalds’ earnings. Consequently, we currently rate McDonalds a long-term hold.
Stock AnalysisA summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
EconomicsWe share some insights on how the recent terrorist attacks in Paris could impact the economy and markets going forward.
Options & FuturesInvesting during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
Investing BasicsHeld onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
EconomicsWill remaining calm and staying long present significant risks to your investment health?
Stock AnalysisIs DKS a bargain here?
Investing NewsA third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
Stock AnalysisHome Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
Stock AnalysisYelp investors have had reason to be happy recently. Will the good spirits last?
Stock AnalysisWalmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>