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Should You Buy McDonald’s?

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On July 27th, 2020 McDonald’s released its most recent quarterly report that sent its shares falling by 2.2%.

Why?

Because its quarterly results weren’t good.

Here are some of the highlights (lowlights) from the release.

Revenue fell by 30% in the 2nd quarter of 2020 to $3.77 billion.

This compared to revenue in the 2nd quarter 2019 of $4.901 billion.

The fall in sales was blamed on coronavirus lockdowns and restrictions worldwide.

Net income fell 68.2% to $482.8 million in the 2nd quarter of 2020 from $1.52 billion in the 2nd quarter of 2019.

And McDonald’s also announced that it now plans to close around 200 restaurants in the US.

None of this is good.

And McDonald’s may not be out of the woods with coronavirus cases still rapidly expanding in the US and worldwide.

But should you take advantage of this drop in share price to buy its shares now? Let’s find out.

How Profitable Is McDonald’s?

Let’s do a quick rundown of McDonald’s profitability and cash flow. Because profits and cash flow drive the long-term value and pricing and value of a stock over time.

I measure this in part by looking at two important metrics.

Operating profits and free cash flow/sales (FCF/Sales).

On an operating profit basis McDonald’s produced an average operating profit margin of 33.3% per year every year over the last 10 years.

This is fantastic.

I look for any company to produce above 10% margins on a consistent basis to consider as an investment. And McDonald’s is 3.33X this level.

What about its FCF/Sales?

Over the last 10 years McDonald’s FCF/Sales is 17.8% on average every year.

Again, this is fantastic.

I look for companies to produce FCF/Sales at higher than 5% on a consistent basis. And McDonald’s crushes this number too.

Both operating profit and free cash flow are important because they help show you the true profitability of the company.

The more profitable a company is, the higher its value goes over time. And the more money it can spend on innovations and serving customers.

I estimate that far fewer than 5% of all public companies on Earth surpass my minimum thresholds for the 2 metrics above on a consistent basis… This means McDonald’s is a great operating business.

But you likely already knew that. What about its valuation?

Is McDonald’s Undervalued?

As a conservative investor I want to recommend solid, safe, and relatively low risk investments to you.

Often those are achieved by high profit margins and low debt. But it’s also necessary to look at valuation too.

Because if you buy overvalued assets there is a lower margin of safety. And doing this makes the investment riskier.

I want to buy assets that are undervalued in a best-case scenario. And at worst fairly valued.

With markets still near their all-time highs as of this writing most great operating businesses like McDonald’s are overvalued…

And it is too.

• Its current P/E is 26.4.

• Its current P/CF is 20.

• And its forward P/E is 35.1.

I look for companies to sell at ratios below 20 on these metrics to consider the investment undervalued.

These metrics show that McDonald’s is overvalued right now by a decent margin.

Because of this, I recommend you stay away from buying its stock right now… Even after its fall due to poor quarterly numbers.

Put McDonald’s on your watchlist and be patient enough to wait to buy it when you can get it at a cheaper price.

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Disclosure – Jason Rivera is a 13+ year veteran value investor who now spends much of his time helping other investors earn higher than average investment returns safely. He does not have any holdings in any securities mentioned above and the article expresses his own opinions. He has no business relationship with any company mentioned above.

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