4 Reasons McDonald's Shares Might Keep Dropping - To $60 Or Less

| About: McDonald's Corporation (MCD)
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McDonald's Corporation (NYSE:MCD) shares were reaching new 52-week highs just a few weeks ago, but concerns about slowing sales in Europe, and a plunging stock market have knocked the shares down. Some might think it's time to go bargain-hunting in this stock, but it could be way too early. Here are 4 reasons to wait for lower prices before considering an investment in this leading restaurant giant:

  1. These shares probably never should have traded over $100. At that price the stock was trading for about 20 times earnings, while the average stock in the S&P 500 was trading for around 13 times. McDonald's is a great company, it has solid management, it is relatively recession-proof, but valuation matters. Thanks to a market correction which still appears to be in progress, the average price to earnings ratio is now down to about 12. If McDonald's were valued at that same level, the shares would be trading for about $68. Perhaps it deserves to trade at a premium, but even at $87 per share, it has a premium of about 30%. This appears too rich, especially considering that many great companies, with much higher growth rates, like Apple, Inc. (NASDAQ:AAPL) are trading for about 10 times earnings.
  2. The markets are getting shaky fast, and there is good reason to believe that the European debt crisis could continue to spread, cause bank runs and sovereign debt defaults, which could then create a Lehman-like market plunge. During the 2008-09 financial crisis, McDonald's shares traded for about $50 per share, which based on current estimates would imply a price to earnings ratio of about 9 to 10 times earnings. Based on that, and what might be an increasingly tough market and possible recession, it doesn't seem like such a stretch for the shares to trade back into the $50 to $60 range.
  3. McDonald's is seeing slow earnings growth. For example, the company reported profits of $1.27 billion, or $1.23 per share, for the first quarter of 2012. That is only slightly higher than earnings of $1.21 billion, or $1.15 per share, in the year-ago period. With economic data showing weakness in Asia, Europe, and now even the United States, the growth might slow even further. It's important to note that Europe is McDonald's biggest market, so growing economic problems, and rising unemployment that already stands at about 11%, could create significant challenges for the company and its shareholders.
  4. McDonald's dividend is decent with a yield of 3.2%, but it's not exceptional, especially considering that many other blue chip Dow stocks yield 4 to 5%. For example, Johnson & Johnson (NYSE:JNJ) yields almost 4% now, and it has earnings estimates of about $5.12 per share for 2012. Johnson & Johnson trades for just around 12 times earnings and it has a higher yield, which is just one example of why McDonald's shares aren't necessarily a great choice for income investors. This also shows why the dividend yield it offers might not be enough to keep the stock from continuing the downtrend.

McDonald's is a great company, and it makes sense to buy the stock at some point; however, with all the challenges facing the global economy and with investors becoming increasingly wary of stocks, patient investors might get much better buying opportunities in the near future.

Here are some key points for MCD:

  • Current share price: $86.71
  • The 52 week range is $80 to $102.22
  • Earnings estimates for 2012: $5.72 per share
  • Earnings estimates for 2013: $6.32 per share
  • Annual dividend: $2.80 per share which yields 3.2%

Here are some key points for JNJ:

  • Current share price: $61.78
  • The 52 week range is $59.08 to $68.05
  • Earnings estimates for 2012: $5.12
  • Earnings estimates for 2013: $5.45
  • Annual dividend: $2.44 per share which yields 3.9%

Data is sourced from Yahoo Finance.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.