Is McDonald’s Stock Overvalued?

Is McDonald’s Stock Overvalued? The world is getting smaller as digital tools connect strangers and create friendships across borders and physical boundaries. However, most companies remain locked in a limited geography, known only to residents in a handful of countries. 

There are very few brands that have achieved worldwide recognition. Those that belong to this exclusive club are well-established leaders in their respective industries. They command premium prices among investors, who are willing to pay a little more for the security of owning stock in a global trendsetter. 

Visa (V), Disney (DIS), and Coca Cola (KO) are some of the icons on this list, along with Apple (AAPL), Google (GOOG), and Facebook (FB). However, when it comes to food, there is really only one winner: McDonald’s.

Certainly, Starbucks (SBUX), Subway, Burger King, KFC, Wendy’s, and Taco Bell have thrown their hats in the ring, but they are essentially competing with each other for the second place slot in fast food. McDonald’s is just too far ahead when it comes to international brand recognition. 

That international brand recognition, along with McDonald’s ability to adapt and change with its environment, have prompted strong stock performance when other restaurants have struggled. Will investors’ faith in McDonald’s be rewarded, or will McDonald’s stock fall? 

Why McDonald’s Stock Went Up?

The Dow Jones Industrial Average (DJIA) is as closely watched as the S&P 500, because it monitors the movements of 30 established blue chip stocks.

McDonald’s is on the list, and it holds a position in the index’s top five most critical companies. McDonald’s makes up roughly 5.2 percent of the DJIA’s total value, which means movement in McDonald’s stock has a decisive impact on investors’ perceptions of the market’s health as a whole.

Investors have taken note of McDonald’s recent increase in value, despite pandemic-related challenges and long-standing concerns about the influence of fast food on public health.

They have watched as McDonald’s adjusted its strategy to manage changes in consumer expectations and mitigate risk associated with external events outside of the company’s control. 

For example, there are always pilot programs in various geographies to test new menu items or alternative methods of serving long-standing favorites.

Further, McDonald’s doesn’t rest its bottom-line results on the sales made at company-owned stores. While McDonald’s does operate some of the locations under its brand, most revenue comes from franchise fees, property leases, and a percentage of the sales made at franchised locations. 

While any one of these factors might not have persuaded investors to continue pushing McDonald’s stock higher through 2020, the combination of factors paints a compelling picture. Investors are willing to pay the higher prices now, because they have confidence that McDonald’s will continue to deliver value through innovation, agility, and steady growth. 

McDonald’s Financials Show Resilience

It’s no secret that 2020 has been tough on McDonald’s, but that’s true for most companies in the fast food and restaurant industries. Stay-at-home orders and dining room closures decimated sales across the board.

Looking at McDonald’s financials in a vacuum gives the impression that the organization is in decline, but through a wider lens, it is clear that McDonald’s is still outperforming the competition. 

McDonald’s plans to provide a complete assessment of third quarter results in early November, but management offered a preview of the numbers a month early.

After dismal first and second quarter sales, the company is now seeing revenue growth in US, Japanese, and Australian markets.

Year-over-year, McDonald’s achieved 4.6 percent growth in comparable store sales for the third quarter, which is a welcome relief after the second quarter’s 8.7 percent decline. 

In addition to this news, business leaders signaled their confidence that the tough year will turn around by raising the quarterly shareholder dividend to a satisfying $1.29 per share. However, that figure represents a 3 percent increase for 2020, which doesn’t measure up to 2018’s 15 percent and 2019’s 8 percent. 

Most investors are glad to see any increase at all, considering the number of companies that dropped or eliminated dividends this year.

A few find the small increase concerning, and it has given them reason to question McDonald’s ability to deliver shareholder value in coming months. 

Will McDonald’s Stock Drop?

It’s never possible to predict with 100 percent certainty what a given stock or the market as a whole will do. Today, there are so many external factors in flux, including the pandemic and the US election, that it’s not possible to make a prediction with any amount of confidence. 

The entire market is likely to experience volatility in coming months, and McDonald’s will probably see its fair share. A drop is particularly likely if the third quarter earnings announcement, currently scheduled for November 9th, shows some of the weaknesses that the company reported for the second quarter. 

However, most analysts agree that even if McDonald’s stock drops, it will resume its steady upward trajectory when market conditions stabilize. That’s good news for those with McDonald’s stock in their portfolios, as it offers assurance that any drops will likely be temporary. 

Is McDonald’s Valuation Too High?

Examining McDonald’s valuation is slightly more complicated than the average company, because McDonald’s has certain competitive advantages that can only be seen from a holistic perspective.

First, McDonald’s is the most valuable food brand in the world, but the key is how much more valuable it is than the second place contender.

Analysts calculate this several ways, so the answer depends on whose research you are reading, but suffice it to say that all agree that the McDonald’s brand is two to three times more valuable than Starbucks. 

Second, there is something to be said for McDonald’s continued ability to expand. Despite most industry experts’ opinion that McDonald’s has saturated the market in the US and has already introduced restaurants in every logical global market, the company still plans to open 350 new McDonald’s locations worldwide in 2020. 

Further, the fast food industry itself is still growing rapidly, especially in North America. A Businesswire report notes that from 2019 through 2027, the size of the fast food market will expand from $647.7 billion to $931.7 billion.

That’s a Compound Annual Growth Rate (CAGR) of 4.6 percent. It stands to reason that McDonald’s will snatch up a respectable share of that growth, given the factors already working in its favor. 

Finally, McDonald’s investors are typically willing to pay a bit more per share given the benefits. It’s a reliable company that can be counted upon to return value for shareholders year after year. Among other things, McDonald’s is firmly committed to sharing profits with shareholders.

The company belongs to the prestigious Dividend Aristocrats club, as it has increased annual dividends for 44 consecutive years. Today, dividends yield approximately 2.4 percent per share. That’s important for income investors who have seen many companies reduce or eliminate dividends during the economic turbulence of 2020. 

Is McDonald’s Stock Overvalued? The Bottom Line

So, the question remains, is McDonald’s stock overvalued? With a current price-to-earnings ratio of 36.18, it’s easy to understand why some might think so. However, this higher-than-average P/E ratio reflects the most recent quarter’s results, which were unusually depressed due to COVID-19.

McDonald’s is a solid company with strong future prospects, so it is more likely that earnings will go up rather than share prices dropping by any significant amount. The bottom line is that McDonald’s stock is not overvalued.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.