Many investors make the same common mistake - associating a stock's share price with its valuation and assuming that a high-priced stock is an "expensive" stock, and a low-priced stock is a "cheap" stock. In reality the actual price of the stock has nothing to do with how "cheap" a stock is trading. To help explain I will be employing several valuation techniques to find just how truly undervalued these fast food industry stocks are.
Listed below are the five (5) largest stocks by market capitalization in the fast food industry: McDonald's Corp (NYSE:MCD), Starbucks Corp. (NASDAQ:SBUX), Yum! Brands Inc. (NYSE:YUM), Chipotle Mexican Grille Inc. (NYSE:CMG), and Tim Horton's Inc. (THI) and their relative valuation ratios.
Company (Ticker )
Current P/E Ratio
Chipotle Mexican Grille
Looking just solely at the per-share price of each stock, McDonald's and Chipotle Mexican Grille are the highest priced of the selected stocks. We also see that Tim Horton's and Starbucks are the lowest priced of the stocks. However this is just purely a share price, and does not fundamentally explain whether the stock is over or under priced.
Current P/E Ratio
The price to earnings ratio is the simplest tool to use when examining how a stock's share price is trading in relation to the company's underlying earnings. Quite simply - the lower the number the more the stock is considered under-valued or "cheap." Of the five largest stocks in the fast food industry it appears that McDonald's and Tim Horton's have the lowest P/E ratios while Chipotle Mexican Grille has by far the largest P/E ratio. Therefore, using the P/E ratio as our valuation technique, McDonald's and Tim Horton's are the cheapest of the stocks.
While the price to earnings ratio does a fine job of determining how a stock's share price is trading in relation to the company's underlying earnings, the PEG ratio determines the level a stock's share price is trading in return to its earnings growth. Therefore, bringing the EPS growth rate into the equation we see that Tim Horton's by far has the lowest PEG ratio, while Chipotle Mexican Grille has the largest. Just using the PEG ratio we see that Tim Horton's is the most under-valued of the stocks while Chipotle Mexican Grille is the most over-valued.
Price to Book Ratio
The final metric here is the company's price to book value ratio. This ratio shows how a stock's price per share is valued in relation to the company's underlying book value (net tangible assets of the company). By using this ratio we see that the most undervalued stocks are Tim Horton's and McDonald's, while the most overvalued is Chipotle Mexican Grille.
The Final Results
After looking at the previous three valuation techniques we can determine which of the five largest fast-food stocks is the "cheapest." The "cheapest" of the stocks is Tim Horton's Inc.. This is due to the company's low P/E ratio, PEG ratio, and Price to Book Value ratio. The most overvalued of the stocks is Chipotle Mexican Grille. In order to show how important these valuation techniques are let's just compare the McDonald's and Starbucks stocks. McDonald's shares cost nearly $50 more than Starbucks, but McDonald's has a lower P/E ratio, PEG ratio, and price to book value ratio, therefore, making McDonald's a relatively cheaper stock despite its higher share price. This just goes to show how important it is to look past a company's share price to determine how under or over priced a stock is.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.