Why McDonald's Oversold Stock Still Looks Expensive

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

McDonald's Corp. (MCD) shares have fallen by over 8% since peaking on January 26, at roughly $178.50, along with the broader stock market. Despite the stock hitting oversold levels on a technical basis, the worst may not be over for the hamburger giant as it continues to hold a high valuation when compared to other companies that have much faster growth rates. 

Earnings are expected to grow over the next three years, while revenue is expected to stay flat, suggesting that any improvement in McDonald's bottom line should continue to come from cost savings or share repurchases, making shares fundamentally expensive. Additionally, McDonald's technical setup is also worrisome as the stock nears a critical support level. (For more, see also: McDonald's Has A Long-Term Growth Problem.)

Overvalued

McDonald's currently trades at roughly 20 times one-year forward earnings estimates of $8.20, the same earnings multiple as Facebook Inc. (FB). What seems most intriguing about how the market continues to value McDonald's, is that earnings are only expected to grow by 8% for McDonald's in 2019 to $8.20, while Facebook is expected to increase its profits by 22% to $8.78 per share. As noted in a previous Investopedia article, it seems hard to justify a McDonald's earnings multiple on par with that of Facebook. In addition to strong earnings growth, Facebook is expected to see its revenue surge by nearly 27% in 2019 to almost $70 billion, to McDonald's declining revenue of almost 1% to $20.94 billion. (For more, see also: Why Is McDonald's Valued Like a Big Tech Stock?)

MCD PE Ratio (Forward 1y) data by YCharts

Cost Savings Driving Bottom Line

McDonald's saw its revenue in 2017 decline by 7% to $22.8 billion from $24.6 billion. Meanwhile, total operating costs and expenses fell by 21%, while the number of diluted shares outstanding fell by 5%. So despite declining revenue, McDonald's was able to boost its earnings per share by 17% on a GAAP basis.

Technicals Breaking Down

To make matters worse for McDonald's, momentum for the stock has seemingly turned bearish. The technical chart shows that in the short term McDonald's stock has become oversold, with a relative strength index (RSI) reading below 30. But the stock began stalling out at the beginning of December when it was trading around $172 and fell to support around $160 during the stock market drawdown. That support level did not hold on two occasions, and it would seem likely it would not hold again if tested.

It is also worth noting that the 50-day moving average has started turning negative as well, another sign that momentum has started to turn bearish. 

With a stock that appears fundamentally overvalued and a technical chart that seems to be turning bearish, the outlook for McDonald's suggests lower prices are in the future. But then again, McDonald's has defied the skeptics before—what's to stop it from defying those same skeptics again? 

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.