McDonald’s (NYSE:MCD) is closing in on $160 a share and I see a lot of commentary online stating that the stock is overvalued at these levels. From an earnings standpoint, the company’s present price to earnings ratio is well ahead of its five-year average of 27. However, the company’s price to earnings ratio actually surpassed 30 before the Great Recession. The present price that we have, is definitely not the highest price McDonald’s has traded at from an earnings standpoint.
Basically, if you look at what happened McDonald’s in the Great Recession, when its earnings multiple came back into sync through drastic improvements in earnings, then there is every reason to say that McDonald’s could do the exact same thing again if equity markets, or even if its own restaurant sector, came down anytime soon. McDonald’s has proven it can gain market share in markets where money is tight or where there is a contraction taking place. I think this is something that investors miss. They always think that just because a company is trading a little higher than normal with respect to an earnings multiple, then it’s overvalued. That’s not necessarily so.
Just look at how the company is looking to increase its earnings. It’s radically digitizing its operations with regard to delivery and with regard to getting food into its customers’ hands as quickly as possible. I think overtime all of these initiatives are going to pay dividends. The company’s also bringing fresh meat into its restaurants. This may in the near term slowdown cooking times to an extent but this point is being over-exaggerated by the bears.
But I do think that, as I’ve said, all of these initiatives eventually will pay dividends. I think McDonald’s is a smart play here, because as the chart above shows, it has rallied aggressively with the S&P 500 (NYSE:SPX) over the past few years. I do think the stock, as it has proved in the past, will hold up very well when the downturn eventually comes.
There has been a lot of question marks raised about its debt which it’s using to buy back shares and the like. Again, all of these symptoms and problems can be sorted out through increased earnings. That’s something that I think is missing from the analysis online at present. Even though the company will probably trade through $160 a share in the near term, McDonald’s remains a very risky short, and I would not be entertaining any idea of shorting McDonald’s here.