Market Multiple Model
We used the Market Multiple Model to analyze McDonald’s with its peer company growth rate,
volatilit...
much lower than the recent trading price of $30.88. Therefore, according to the Price/Earning
Multiples, our opinion is th...
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Market multiple model

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Market multiple model

  1. 1. Market Multiple Model We used the Market Multiple Model to analyze McDonald’s with its peer company growth rate, volatility, and return on equity (ROE). As a result of the analysis, we made a judgment as to whether McDonald’s is average, better or worse than it’s peers. We then estimated the expected Price/Earnings (P/E) and Price/Cash Flow ratios of McDonald’s, given the relationship between its ratios and those of its peers. This valuation model is commonly used, but does not provide the same level of information as the other two models. Both the dividend discount model and the discounted cash flow model look at the present value of future cash flows. We use this model simply looks at how a few of McDonald’s ratios compare to those of its peers, and set a valuation of the company accordingly. Price/Earning Multiples Price/Earnings are the most useful and widely used of all valuation multiples. Before we analyze the P/E ratio of McDonald’s, we compare its growth, beta and profitability with its peer companies. The Future Growth rate of McDonald’s is 11.50%, the Beta is 0.90, and the ROE is 20.20%. This data represents McDonald’s as an average company (no better nor worse than its peer companies, Wendy’s and Tricon). However, McDonald’s current P/E is 22.35, which is much higher than its peers are. Although McDonald’s P/E ratio is still lower than the S&P 500 median P/E ratio of 29.00, we decided to adjust its P/E to an average ratio. We made this adjustment because we feel that the market will consider paying a higher P/E to a company only when it has a higher growth rate, a better past performance, a higher expected future growth, a lower risk, and a higher profitability. Since all these situations do not seem to exist in McDonald’s, we needed to adjust its P/E ratio to an average ratio of 14.71. When we use the average P/E ratio times the earnings in 1999; we calculate price per share of $20.44, which is
  2. 2. much lower than the recent trading price of $30.88. Therefore, according to the Price/Earning Multiples, our opinion is that the current trading price of MCD is too high. Price/Cash Flow Multiples From the above Price/Earning Multiples, we have already explained that McDonald’s position of Future Growth, Risk (Beta), and Profitability (ROE) is only average in comparison to its peers. However, McDonald’s has a much higher P/CF ratio compared to its peers, 14.91. According to the Market Multiples principle, we feel McDonald’s high P/CF ratio is not justified. Therefore, we adjusted McDonald’s P/CF ratio to an average of 10.03. We use this average P/CF ratio times the Cash flow per share in 1999. The price per share we calculate is $21.57, which is much lower than the recent trading price of $30.88. Therefore, based on the Price/Cash Flow Multiples, we concluded the current trading price of McDonald’s is overpriced. In addition to the above two Multiples, we can use a more direct method to verify if McDonald’s recent trading price is too high. As in normal practice, when making a decision to buy a business, many potential buyers or investors would multiply the company current year revenue by 2 to determine a reasonable trading price. If the business of the company is considered very attractive, they would use multiple of 3. When we use McDonald’s 1999 revenue per share, $9.82 times 2, we get an amount of $19.64, which is much lower than the recent trading price of $30.88. Only when we use a multiple of 3, do we get an amount of $29.46, which is closer to the recent trading price of $30.88. However, based on the Multiples above, we feel that McDonald’s is an average company, it seems that it does not justify paying three times of its yearly revenue to buy its stock.

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