Trading at almost 27x earnings and with an array of challenges ahead, shares of McDonald’s (MCD) look fully valued right now. It pains me to say this because McDonald’s is an iconic American success story that has delivered incredible returns to shareholders for decades, but the company looks more like a Hold than a Buy at this point in time.
Valuation
At over 26.6x earnings and 25.3x forward earnings, the valuation seems to be fully realized at present. In a market where high-multiple companies are seeing their multiples contract, I don’t think MCD’s multiple will tank, but it is unlikely that it will expand meaningfully from here.
A P/E of near 30x would normally be seen in companies exhibiting rapid growth, not a mature business like McDonald’s. For example, a company like Coinbase (COIN) is trading at just over 17 times earnings, which is below the multiple for McDonald’s. Alphabet (GOOG), which is still growing quickly for its size, is trading at 27 times earnings.
I will give McDonald’s credit for its dividend. The payout currently yields just over 2%. This isn’t a bad yield per se, but I would want to see it higher before adding McDonald’s to my radar as an income investment.
McDonald’s looks like it is priced for perfection right now, and unfortunately, as you will see below, this does not seem like the perfect operating environment for the company.
Wage and Commodity Inflation Challenge Top Line and Bottom Line
We’ve all heard about the ‘Great Resignation’ and how companies are having trouble attracting employees to come back to work, especially at the bottom of the wage pyramid.
This is a challenge for fast food franchises like McDonald’s, and you can see this coming into fruition by the fact that some locations are operating with reduced hours or as drive-thru only.
This will, unfortunately, hurt companies like this on both the top and bottom lines – increasing wages to attract employees and achieve adequate staffing eats into the bottom line while operating with reduced hours reduces top-line growth.
Not only does McDonald’s have to contend with rising wages and getting its locations properly staffed up again, but franchises are also dealing with inflation in terms of food costs.
Take a look at rising beef prices, a key input for McDonald’s. The Bureau of Labor Statistics reported a 20% increase in the price of beef year-over-year from 2020 to 2021. The fact that even the White House has gotten involved in trying to slow the rise of beef prices is telling, and it’s probably not a good sign for where they are going.
McDonald’s can certainly pass some of these costs on to the consumer, but at some point, it will take a bite out of the bottom line.
Wall Street’s Take
Turning to Wall Street, McDonald’s stock comes in as a Strong Buy. I may be swimming against the tide here as 23 of the 27 analysts covering MCD rate it as a Buy while only four call it a Hold. There are no Sell ratings on the stock at present.
However, I note that the average McDonald’s price target of $284.08 represents just 10.2% upside from current pricing, so I take some solace in my ‘Hold’ rating from that.
The Street high price target of $314 is almost 22% above the current share price, which would mean I am wrong about this being a Hold, but in reality, 22% doesn’t seem like a screaming Buy that I would be excited about either. The lowest analyst price target of $260 is just slightly higher than today’s share price, indicating that downside may be limited as well.
Takeaway
I don’t think McDonald’s is a particularly risky investment or one that will go deep into correction territory like many of the high-multiple tech stocks have recently. I don’t see it as a short, nor am I going into full-on bear mode, but valuation seems priced for perfection despite the fact that there are plenty of challenges to navigate.
I’ll give the company credit for its dividend payment, and I’m sure its ongoing digital transformation will pay off in the future as well. It is an iconic American company that has rewarded shareholders handsomely for years, and it is also probably a fairly safe, stable place to park some money in a volatile market.
However, ultimately, I see the upside as limited in the short term, and I would wait for a significant pullback in shares of MCD or a dividend increase before reevaluating it as a buying opportunity. Right now, I view McDonald’s as a Hold.
Download the TipRanks mobile app now
To find good ideas for stocks trading at attractive valuations, visit TipRanks’ Best Stocks to Buy, a newly launched tool that unites all of TipRanks’ equity insights.
Read full Disclaimer & Disclosure
