A quick look at the Graph for McDonald’s (MCD – Free Value Line Research Report for McDonald’s) shows an impressive stock chart over the last decade. Note that the really impressive stock price run began about nine years ago—just shy of an actual decade. In fact, those owning McDonald’s shares through 2002 would have likely felt sick to their stomachs, as it fell from about $30 in mid-2002 to a low of just $12 in early 2003. That stock drop wasn’t an accident; it was precipitated by concerns about the company’s growth prospects and management’s business decisions.
Still, once the fast food giant’s shares hit bottom, an impressive run began, taking the shares from the aforementioned $12 low to recent prices above $100 a share. That’s not bad if you had purchased the stock somewhere along the way. In fact, the recent recession barely touched the shares, which largely traded sideways through the economic malaise (recessions are denoted by gray bars on the Graph). Note, too, that the relative strength of the company’s shares has been largely trending higher over the past year, too. (Relative strength is displayed as a dotted line on the Graph—a rising line denotes an increase in relative strength, a falling line the opposite.)
Just as impressive as the price chart are the historical revenue and earnings numbers presented in the Statistical Array. Both figures have trended solidly higher since earnings hit a rough patch early in the new century. In fact, Revenues have increased at an annualized rate of 8% over the past 10 years. Impressively, earnings have increased at an even faster rate, jumping by an annualized 11.5% over that period—with even more impressive gains over the trailing five-year period. These figures can be found in the Annual Rates box.
In that same section of the Value Line report, the annualized growth rates implied by Value Line’s revenue and earnings projections are also presented. Here, the growth rate for revenues is expected to inch up slightly to 8.5% over the next three to five years, while earnings are projected to taper off to a still solid growth rate of 9.0%. Note that growth of this magnitude for a company with a $100 billion market cap is pretty impressive. (A company’s market cap can be found in the Capital Structure box.)
So Value Line’s analyst thinks that McDonald’s can keep putting up solid numbers for a while. This suggests that a long-term investment might make sense. This is especially true if one takes into account other factors, such as risk. The stock earns a Safety rank of 1 (Highest) and has a Financial Strength score of A++ (the best score Value Line awards). These are both proprietary Value Line measures that suggest a very stable company. Safety can be found in the Ranks box at the top left of the report, while Financial Strength is on the bottom right in the Ratings box.
So far the checklist is impressive: Good recent price action; good recent company performance; good business prospects. What about the price?
Here, Value Line provides a number of metrics that will help, including P/E, relative P/E, and dividend yield. These figures show up in several different locations on the report providing the current figures, historical figures, and projected figures. Without going into detail, these figures don’t provide a clear picture. The P/E is toward the high end of its historical range, perhaps suggesting a fair valuation. The Relative P/E, however, is quite high compared to recent history. The Dividend yield is toward the high end of its historical range, suggesting fair or better valuation. The end result is likely a great company trading around a fair valuation.
However, the Cash Flow line may provide some help here. The cash flow line is the solid line (with dashes at the end) that appears on theGraph. It is created by taking a “best fit” multiple of cash flow per share that allows the line to roughly track the stock chart. This, then, is the multiple of cash flow that investors are willing to pay for the stock. Visually, when the shares are trading above the line they are likely overvalued and when trading below the line they are viewed as undervalued. The dotted lines at the end of the cash flow line are based on Value Line’s estimates.
A quick look at the Graph, than, can tell a lot about a company’s valuation. In McDonald’s case, it was deeply undervalued based on the Cash Flow Line in 2002 and 2003. It traded close to the line through 2011. But, based on Value Line’s estimates, the shares are trading well above the line. At the end of the day, investors looking to own shares in what many would argue is a great company, should probably wait for a pullback from recent levels.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.