McDonalds_2-300x220Event: On Monday, Wall Street firm Lazard Capital Markets downgraded shares of McDonald’s (NYSE: MCD). Previously Lazard rated McDonald’s a buy, but it now has the stock neutral. The reason for the downgrade is increased competition. Lazard cited McDonald’s weak sales numbers that failed to show growth in the last two quarters and a management shakeup that could negatively impact future growth. Shares of McDonalds traded lower on Monday after the downgrade.

Analysis: Not mentioned once in the downgrade was a little something I call “valuation.” Valuation does matter, and in this instance the downgrade was much justified. The analysts missed an opportunity. The competition and management arguments are a bit weak and can be made by anyone at any time. Valuation is the truth. It is what ultimately matters in a sea of irrational investors mispricing stocks day in and day out. In the case of McDonald’s, the stock is simply overpriced. Analysts on average expect profits to grow by only 9% in 2013. At current prices, shares trade for 16 times current year estimated earnings. Add in the fact that McDonald’s missed estimates in the last two quarters and one can easily see the risk to the downside here. In fact, the analyst got the call right, if not for the right reasons.

Action: One might consider owning puts on McDonald’s or flat-out shorting the stock here for a three-month trade.


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