McDonald's Investment Analysis: Applying Financial Models and Ratios

This case study provides a financial analysis of McDonald's to determine its investment potential, employing several valuation methods including the Dividend Discount Model (DDM), Discounted Cash Flow (DCF) model, and comparable company analysis. The analysis begins with a background ...Read More

Financial management
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Good company to invest in –
Once the company has adequate funds
the next thing is deciding about the
company in which to invest the funds.
To analyse any company before
investing, its background, financial
dealings, management type and various
other things are required to be
considered.

Company background –
McDonald’s is the fast food company
limited by service restaurant that has
more than 35000 restaurants over
more than 100 nations. It serves more
than 75 million customers each day
with having more than 4 million
employees.

Dividend discount model (DDM) –
DDM is used for valuing the stocks
that uses the theory that the worth
of a stock is sum of all the future
dividends. Using the cost of capital,
stock price and next year’s value of
dividend the intrinsic value of the
stock can be determined.

Major advantage of DDM model is
that is is most widely used method
for computing the share prices and
therefore is easiest method to
understand. It is used for valuing
the stock of the company without
considering the market conditions.
Hence, it is easier to compare the
entities of different sizes and from
different industries.

Discounted cash flow model (DCF)
DCF model is particular type of the
financial model that is used for valuing the
business. It is simply the forecast of
entity’s unlevered free cash flow that is
discounted back to present value. DCF is
process of computing present value of
investment’s future cash flows for arriving
at estimation of current fair value.
DCF = CF1/(1+r)1 + CF2/(1+r)2 +
CF3/(1+r)3 ...+ CFn/(1+r)n

Main advantages of DCF method is that
is offers closest estimate for the
intrinsic value of a stock. It is
considered as most appropriate method
for valuation if analyst is confident
about the assumption. Further, unlike
the other valuation DCF depends on the
free cash flow that is considered as
reliable for estimating the subjective
policies for accounting.

Comparable method
Comparable analysis process is used
for evaluating the company’s value
through using metrics of the other
businesses of the similar size from the
same industry. It is done on the
assumption that the similar entities
will have same valuation multiples like
Price earnings ratio.

The main advantage of this method is
that it can be used for comparing the
peers from the same industry.
Further, it is easier to understand and
it uses fewer assumptions as
compared to other methods like DCF.
Further, it captures the present mood
of the market.

Dividend discount model

Value of the stock = D1 / (r – g) = D0 * (1+g)/ (r –
g)
Expected rate of the return = E(r) = Rf + β (Rm –
Rf)
= 3.11 + 0.64
(12.47 – 3.11)
= 9.10%Value of stock = D1 / (r – g) = D0 * (1+g)/ (r – g)
= 4.19 * (1+0.075) /
(9.10 – 7.45)
= 272.98
(Finance.yahoo.com, 2018).

Enterprise value (EV) = Value of stock *
number of
shares
= 272.98 * 794497880
= 216.88 billion

Discounted cash flow model (DCF)
Weighted average cost of capital
WACC = 82% * 9.1% + 18% * 2.06% = 7.84%

Comparable method
The benchmark –
Starbucks Corporation – the company was
incorporated on 4th November 1985. It is a
marketer, roster and retailer of the coffee. It
roasts and purchases coffee that is sold by it
along with the tea, handcrafted coffee, wide
range of the fresh foods and different types
of beverages.

Compass group PLC – It is leading food
and support service entity in the world
that can be traced back for more than 60
past years. It is specialised in offering
food and wide range of support services
all over the business and industry sector
of healthcare and seniors, defence,
education, remote and offshore.

Yum brands – As the restaurant company
Yum brands put faces of the people around
and satisfies its customers each time they
eat the foods and does it better as compared
to other restaurant company. It is the
largest quick service restaurant that is
concerned in world with regard to unit terms
with more than 33,000 locations over 100
countries.

Price earnings ratio
P/E ratio is the relationship among the
company’s share price and earnings per
share. It gives the idea regarding what the
market is willing to pay for the earnings of
the company. It is important while valuing
the stock of company as the investors want
to assess how profitable will be the company
in future.

Comparison with peers
P/E ratio = Stock price per share /
EPS
= $ 186.43 / $ 6.43 =
28.99.

Price to sales ratio
PS ratio is the relative valuation measure as it
is useful only when compared to the PS ratio of
the peers. It varies dramatically by the type of
industry. For instance, the PS ratio for retail
industry is generally high as compared to the
companies from research and development
industry.

PS ratio = Price per share / annual net sales
per share
= $ 186.43 /
(12718900000/794497880) = 11.6
It can be noticed from the above table that
the PS ratio of McDonald is highest among
all that is 11.65. Hence, it can be stated that
the company is a good choice for the purpose
of investment (Corporate.mcdonalds.com,
2018).

Price to book ratio –
It is the financial ratio used for comparing the
market value of the stock to the book value of
share. It indicates whether the asset value of
the company is comparable with the market
price of the stock and therefore it can be used
for finding the stock’s value.
P/B ratio = Stock price / book value per share
P/B ratio = $ 186.43 / -4.12 = -45.25

EV/EBITDA ratio –
It is used for valuing the company and used
with the P/E ratio. As it includes debt, it
gives much more accurate valuation and
this is considered as the main advantage of
this ratio.
EV/EBITDA -
Enterprise value (EV) = $ 216.88 billion = $
21,688 million
EBITDA = 13,267.7 million
EV/EBITDA = 1.63

Liquidity metrics –
It shows whether the company is able to meet
the short term liquidity with the current
assets available with it. Generally the ratio of
more than 1 indicates that the company has
sufficient current assets to pay off the
current liabilities. Both the current ratio and
quick ratio of the company is indicating that
the company has sufficient current assets to
meet its current obligations.

Result –
Dividend discount model – Undervalued
Discounted cash flow model –
Undervalued
Price earnings ratio – Highest among
peers
Price to sales ratio – Highest among
peers
Price to book ratio - Undervalued
Other ratios - healthy
Therefore, it is recommended that the
fund shall be invested in McDonald.

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Finance.yahoo.com. (2018). Retrieved 18 December 2018, from
https://finance.yahoo.com/quote/MCD/
Corporate.mcdonalds.com. (2018). Retrieved 18 December 2018, from
https://corporate.mcdonalds.com/content/dam/gwscorp/investor-relations-content/annual-
reports/McDonald%27s%202017%20Annual%20Report.pdf