McDonald's (MCD) is one of the best managed companies in the world. CEO Jim Skinner has done a fantastic job of turning the company into one of the strongest brands the world has ever seen. However, just because a company is great doesn't always mean the stock is a buy.
When a real estate agent shows you a piece of property they always say the three most important words in the business are location, location, and location. In the market, the three most important words are valuation, valuation, and valuation.
I have been wanting to make McDonald's a part of my portfolio for a very long time, but just can't due to various disconnects with its current stock price and business. While McDonald's business is strong, the stock price has been pricing in way too much growth.
McDonald's gave guidance on its earnings and revenue figures on Friday. McDonald's APMEA regions saw sales fall 1.7%. This is concerning because the growth in the Asian region was a big reason why McDonald's was trading at heavier multiples than other fast food companies. The company plans to open another 250 restaurants in China with a goal to have 2,000 restaurants by 2013.
McDonald's currently has a forward P/E of 14. Considering McDonald's growth in the North American market has matured, it is mainly looking to emerging economies such as China. If China slows then McDonald's main source of growth slows. The P/E ratio would fall to reflect the company's growth prospects.
McDonald's is also seeing heavy competition from companies such as Yum Brands (YUM). Yum's stock fell after McDonald's gave guidance for China. Yum's stock has been similar to McDonald's in that there has been a large amount of growth priced into the company. Last Monday, an analyst from Raymond James downgraded Yum on the belief that the stock has peaked due to slowing growth in China. Yum also has a forward P/E of 16.72.
McDonald's has a PEG ratio of 1.58 and Yum has a PEG ratio of 1.4. So based on growth projections, the market has priced in a significant amount of growth into the valuation. If China continues to stall on fast-food sales, both stocks will take a hit. In addition, they are both competing against each other, which is an issue as well. While I am a fan of McDonald's as a business, the valuation of the stock at this price is somewhat pricey.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.