Whether you’re a seasoned investor or new to the market, McDonald’s is a popular stock that often catches the eye due to its robust fundamentals and iconic global presence. In this post, we’ll analyze the company’s key financial metrics, business model, and valuation methods to help you decide if McDonald’s is a worthy investment for your portfolio.
What’s in the News for McDonald’s?
McDonald’s has made headlines recently, particularly during the U.S. election season. There’s been buzz around a claim made by one of the presidential candidates that they worked at McDonald’s. This news, although it might seem trivial, keeps the company in the media spotlight. As election debates heat up, McDonald’s remains a topic of discussion, making it an interesting time to evaluate its stock.
McDonald’s Fundamentals: A Closer Look
McDonald’s fundamentals remain strong, and that’s why the stock has maintained its appeal over the years. Let’s break down some of the key metrics:
- Dividend Yield: McDonald’s boasts a healthy dividend yield of 2.1%. Additionally, with a dividend payout ratio of 53%, the company appears to be on solid financial footing, distributing consistent returns to its shareholders.
- PE Ratio: The company’s PE ratio is currently at 21, which is in line with industry standards, particularly when compared to other consumer goods giants like Starbucks.
- Profit Margins: McDonald’s gross profit margin of 55% and operating margin of 53% demonstrate the efficiency of the business. Their ability to optimize operations, coupled with the strength of their brand, contributes significantly to these figures.
Key Ratios That Matter
For investors, several key ratios can provide insights into McDonald’s operational efficiency and potential for future growth:
- Net Earnings Ratio: Over 20%—a strong indicator of profitability.
- Debt Coverage: McDonald’s long-term debt is covered by its free cash flow, at a rate of 5 times, showing strong financial health.
- Share Buybacks: McDonald’s has consistently bought back shares, increasing the value for existing shareholders. In fact, 15.75% of shares have been repurchased recently—a positive sign for investors.
Understanding McDonald’s Business Model
One of the key factors behind McDonald’s success is its franchise model. Around 95% of McDonald’s locations are franchises, which means the company earns steady, recurring revenue through franchise fees while keeping operational costs low. McDonald’s typically owns the land on which these franchises operate, creating a dual revenue stream from both real estate and franchise operations.
This business model makes McDonald’s a reliable cash generator and positions it as a long-term player in the fast food industry.
Valuation Methods: How We Evaluate McDonald’s Stock
Now let’s dive deeper into the various valuation methods we use to assess whether McDonald’s stock is priced fairly.
1. Discounted Cash Flow (DCF) Analysis
The discounted cash flow method estimates the present value of McDonald’s future cash flows, factoring in its efficiency and operational excellence. Here’s how we break it down:
- Projected Free Cash Flow Growth: We assume McDonald’s free cash flow growth will be 10-15% annually due to its robust operational efficiency.
- Discount Rate: For DCF, we typically use a discount rate of 10%, which accounts for the risk of investing in individual stocks versus the broader market.
- Valuation: Based on the DCF model, McDonald’s intrinsic value is estimated at $157 per share.
2. Benjamin Graham’s Formula
The formula of Benjamin Graham mainly focusses on the growth rate and the company’s current EPS ratio. According to this formula, Mc Donalds should be priced around $102.
3. Warren Buffett’s Rule of Thumb Formula
Similar to the Benjamin Graham Formula, the rule of thumb formula uses the same input however it undermines the 4.4% high yield bond rate that Benjamin included. Therefor this valuation is always slightly higher and prices the stock at around $146.
4. Target Valuation Formula
This formula emphasizes on the current EPS, an estimated P/E Ratio, growth rate and the period you are planning on holding the stock. This formula returned a valuation of $263
5. Intrinsic Value (NPV) Formula
This formula is a bit more elaborate and includes the cashflow, discount rate, number of periods, and residual value. This formula returned a price of $118.
Average valuation
Most statisticians know that the average is (almost) always right. Therefore, we are interested in what the average of all five formulas is. The average of all the formulas that we used is $157.63 which is a lot higher than the price it is currently trading for ($289).
Now let’s dive deeper into the various valuation methods we use to assess whether McDonald’s stock is priced fairly.
Should You Invest in McDonald’s?
While McDonald’s is a household name with an exceptional business model and solid fundamentals, its current stock price suggests it might be overvalued. However, if you’re a dividend-focused investor or looking for a stable, long-term addition to your portfolio, McDonald’s is certainly worth considering—especially if the stock price dips to more reasonable levels. But keep in mind that this valuation is based on our assumptions and should not be taken as financial advise.
Conclusion
McDonald’s is a well-established brand with strong financials, making it a potentially attractive stock for long-term investors. However, based on various valuation methods, McDonald’s appears to be overvalued at its current market price. It might be a good idea to keep the stock on your watchlist and consider purchasing when prices align more closely with its intrinsic value.
As always, do your own due diligence before making any investment decisions. If McDonald’s stock aligns with your investment strategy, it could become a valuable asset in your portfolio for years to come.
