What a surprise. McDonalds (NYSE: MCD ) beat its earnings estimate for Q4 2011.
It was the 14th time in the past 16 quarters that the world's most
recognizable restaurant chain topped expectations; the other two were merely met
estimates. The announcement also topped off the sixth straight year of improved
earnings, and I'm sure if I dug further back I'd find more of the same
degree of raw earnings success. Of course, the market repaid this ridiculously
consistent growth by sending the stock more than 2% lower on Tuesday. How does
that old cliché go? Buy the rumor, sell the news? Looks like we have a case of
it right here. Actually, it was 2012's outlook that got the blame for
McDonalds demise yesterday. Apparently the market isnt keen on the company's
plan to keep spending, especially against a backdrop of exchange rates that are
now going to be working against the company after working for it in 2011. Might
I propose a different reason for Tuesday's dip, though a reason investors
might subconsciously feel, even if they don't blatantly recognize it?
McDonald's Ain't Cheap Some of very first investing advice I remember
getting was something along the lines of "Don't buy stocks buy
companies." It was the cute and efficient way of remembering that
stock-picking had everything to do with owning proven, successful companies, and
nothing to do with an individual stock's valuation measures. It also was the
worst investing advice I ever got. Oh, the underlying idea is spot-on. A bunch
of expensive (high P/E ratio) stocks have managed to dole out massive rewards
while technically overpriced. Take Amazon (NASDAQ: AMZN ). The stock has not
traded under a P/E of 30 since 2008 (and most of that time, the P/E was above
60), yet AMZN shares are 266% higher now than they were then. Amazon is a
decided exception, though. In most cases, the valuation will catch up with you
eventually. Enter McDonald's, stage right. Not that its trailing P/E of 19.3
is unthinkable for many of the market's stocks, but for MCD, that's the
highest it has been in a normal environment since 2007. (McDonald's
deliberately dipped into the red ink once in 2003 and again for one quarter in
2007, pushing the P/E ratio above 19 at the time.) Said more bluntly, it's a
frothier valuation than the company could have justified anyway, with or without
concerns about this year. The Rest of the Story That last assumption might be
feather-ruffling for many of you, considering how highly comparable Yum! Brands
(NYSE: YUM ) is trading at a trailing P/E of 24.4, and 2012's expected income
isn't going to help much on that front. Wendys (NASDAQ: WEN ) is in the hole
for the last four quarters, and even if the current year goes as well as
planned, it's still priced at 24 times its anticipated 2012 earnings.
McDonald's shares already are cheaper than that, and I'll even go one step
further and say I feel McDonald's is a better-managed (not to mention more
reliable) company than Yum! or Wendy's. So what's the problem? Like I said
above, sadly, the stock-picking game isn't about finding great companies
anymore. It's about outguessing what the rest of the market is going to think
about stocks six to 12 months from now, and getting out in front of the crowd
before other investors make their move. And that annoying reality is what makes
McDonald's doubly vulnerable now. The market doesn't expect much from Yum!
or Wendy's, and understandably so neither has been a picture of consistency
of late. Oodles of investors are counting on McDonald's to keep cranking out
earnings increases, though. And now that it might not meet those expectations,
these same folks are likely to look down from the dizzying heights of the 72%
gain since late 2009 and decide they don't like the view. Said another way,
all of a sudden that 19 P/E turns from being an acceptable premium for a quality
company to an unacceptable liability. Funny how that happens as often as it does
when a stock gets as overbought as MCD is right now. Bottom line: McDonalds is a
great company, to be sure, and I suspect fears of weak results in 2012 are
overblown MCD always finds a way. Nevertheless, investors looking to get into
this great company can only do so by getting into the stock and the stock is
apt to be much cheaper within a few weeks now that the weight of the recent
gains is bearing down. As of this writing, James Brumley did not hold a position
in any of the aforementioned stocks.
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