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Using a Value Line Report: McDonald’s is Looking Pricey – December 2, 2011
McDonald’s (MCD – Free Value Line Research Report for McDonald’s) is viewed pretty much universally as a great company. It’s gone through periods of hardship, such as the late 1990s and early 2000s, when investors feared that management had lost its way, but it has managed to thrive, despite the issues it faced.
Looking at its history, the shares reached a low of just $12.10 in 2003 (the high and low price for every year is shown above the Graph). This isn’t surprising, however, given that the 2001 recession (recessions are shown on the Graph with a shaded bar) led to a year-over-year earnings decline that was followed by another year-over-year drop in 2002. One would have expected an earnings rebound coming out of a recession and perhaps even higher earnings through a recession as consumers trade down to cheaper eats. The historical section of the Statistical Array shows the year-by-year earnings.
However, the company’s performance during the 2007 to 2009 recession was much more impressive, suggesting that current management is doing a better job than management of a decade or so ago. That said, one of the most alluring things about McDonald’s is the strength of the fast food giant’s concept. Not only is it ubiquitous in the United States, but it is known, and operates, the world over. In fact, as the Business Description notes, the company derives about two-thirds of its revenue from abroad.
Adding to the allure of the fast-food chain is the fact that it operates with a reasonable amount of debt for its size and earning power. At 45% of capital (found in the Capital Structure box) McDonald’s has plenty of financial flexibility to continue its worldwide expansion efforts. Moreover, with almost $2.4 billion in cash (found in the Current Position box), there shouldn’t be any problems funding day-to-day operations. This is particularly true when considering the nature of the business, in which large volume of small regular purchases are the norm.
Solid dividend and earnings growth rates, found in the Annual Rates box, are another positive. Although analyst Mathew Spencer expects these growth rates to slow over the next three to five years, the projected growth is still near 10% for both items—solid performance numbers, to say the least. The recent yield of 3% is also intriguing (this figure can be seen in the Top Label section) and at the high end of the historical range for the stock, a fact that can be ascertained by reviewing the historical portion of the Statistical Array.
Many of these factors lead to the stock’s top-notch marks for Financial Strength (A++, found in the Ratings box) and Safety (1, founding the Ranks box). Additional positives are the high scores for Price Stability, Growth Persistence, and Earnings Predictability, all of which can be found in the Ratings box.
So what’s not to like?
Although the recent P/E, found in the Top Label section of the Value Line report, is around the middle of the company’s historical range, the recent Relative P/E is near the high end of its range. This suggests that while the stock may not be overvalued relative to its own history, it is likely a bit overpriced relative to the market. This could lead to a stagnant share price as the market plays catch up, or a share price decline. Of course, the stock could simply keep going—it’s had a good run over the trailing 12 months through October, advancing 23% versus the broader market’s gain of just 4.9%.
That said, a Value Line Timeliness Rank of 3 (Average), found in the Ranks box, suggests just average performance over the next six to 12 months. So while the stock may present some interest for longer-term investors with conservative profiles, more aggressive investors may want to look elsewhere for now or sit on the sidelines and await a better entry point.
This isn’t to say that McDonald’s is a bad company; it clearly is not. But a good, some might argue great, company isn’t always a good investment. The market, however, is always in flux and shares of good companies often bounce around a fair amount in a year. So, finding that shares in a company like McDonald’s are too expensive one day doesn’t mean you should remove them from your wish list. In fact, keeping a wish list of good companies and waiting for the right entry point is a tried and true investment approach. For most, McDonald’s should probably stay on the wish list for now.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.