Shares of McDonald’s (NYSE: MCD) finally have stalled out after a monster move higher. MCD stock has risen nearly 20% after bottoming at at the $158 area in mid September. The red-hot rally is even more impressive given that the S&P 500 and the Dow Jones have actually fallen in that same time period.
All good things, however, come to an end. Now that both fundamentals and technicals are at extremes, I look for McDonald’s to struggle over the coming months.
MCD stock is now sporting a trailing P/E over 28, the highest multiple of the past 10 years. McDonald’s stock is also trading at the biggest valuation premium to the S&P 500 over that same time frame. MCD is certainly no longer a value stock.
Price to sales (P/S) paints an even clearer picture of over valuation. MCD carries a nearly 7 times P/S ratio, by far the highest levels over recent years.
The near-parabolic rise over the past few months is more akin to a high-flying internet stock than a Dow Jones component. Eventually, valuation does matter.
Growth has been solid recently. Similar future growth rates, however, will be increasingly more difficult to maintain simply owing to the increased size ($145 billion market cap) and the law of large numbers. Expect a multiple contraction for McDonald’s stock price as valuations realign.
McDonald’s is also looking stretched on a technical basis. Money flow has weakened considerably. MCD stock also just put in a bearish island formation. Shares gapped to all-time highs at $190 only to reverse and close lower, and also below the $188 level. This type of price action is many times indicative of a blow-off top in the stock, especially after such a big rally.
The shorts have likely all covered and the buyers finally look to be exhausted.
The impetus behind the gap higher was an upgrade by Morgan Stanley to overweight from equal weight. Analyst John Glass upped the price target from $173 to $210, noting that a defensive stock such as MCD tends to outperform the S&P 500 during periods of decline. While the initial reaction was the usual lemming-like buy at any price, a reality check ultimately sent MCD shares lower.
Given that MCD stock was at $190, the new $210 price target represented only a 10.5% upside — certainly not a lot given how far the stock has rallied in just the past few months. Saying that McDonald’s will go down less during a market pullback is not a compelling reason to buy either, especially given the rich valuations.
Investors and traders looking for a short to help balance out their portfolio would be well served to consider MCD stock as a very viable candidate.
Tim Biggam may hold some of the aforementioned securities in one or more of his newsletters. Anyone interested in finding out more about Tim and his strategies can go to https://marketfy.com/item/options-and-volatility.
