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A look at MacDonalds NYSE:MCD

Analysing companies' finances and value from their financial statements using ratios and formulae
TheMotorcycleBoy
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A look at MacDonalds NYSE:MCD

#231440

Postby TheMotorcycleBoy » June 22nd, 2019, 5:33 pm

So I've started to look at Maccy Ds. Got to fulfill Buffett's criteria of being a business that I can understand, right?

Anyway, after looking at Microsoft (MSFT) fin. statements, I quite like the US ones (i.e. their ARs). They are short and sweet (so far I've only looked at MSFT and MCD), i.e. no stupid power point style meaningless pictures, and sound-bites like some of the Brit ones I've seen.

However, where there's a silver lining, sometimes there's a cloud.

In find, some of Yank semantics of words such as "net" slightly different than ours, plus their notational conventions (I find) are sometimes less obvious.

My current contention is Interest income and expense. If we look at an example of a UK registered firm e.g. Croda (CRDA), we see in their P&L statement (https://www.croda.com/en-gb/investors/annual-report#) we can see on page 100:

Financial costs  (12.1)
Financial income 1.1


Here it seems like the net position re. interest is -11.0. (They owe the bank £11M)

However for MacDonalds we see two entries on page 26:

[1] Interest expense-net of capitalized interest of $15.5, $15.9 and $14.0	521.90 
[2] Nonoperating (income) expense, net 37.90

After some head-scratching (and looking around the rest of report) I believe their net interest position is: -559.8. (They owe the bank $559.8M).

I believe that entry [1] is always an expense, and the "net" bit means "includes" the 3 separate capitalized interest items. And I believe that [2] is to be interpreted thus:

If the following figure is parenthesised then this is income, hence positive, whereas if unadorned it's an expense i.e. negative.

Anyone got any opinions/comments on this?

thanks Matt

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Re: A look at MacDonalds NYSE:MCD

#231567

Postby TheMotorcycleBoy » June 23rd, 2019, 4:43 pm

Fundamental analysis from 2013-2018



Note -ve equity from 2016. Due to large amount of debt taken to buy back stock (see "diluted number of shares") and (I think) Capital investment in more premises.

Business is attempting to become 95% franchised in next couple years. Note increase in OM.


If I understand the wording of this (page 28 of AR 2018) correctly:

Certain of the Company’s debt obligations contain cross-acceleration provisions and restrictions on Company and subsidiary mortgages and the long-termdebt of certain subsidiaries. There are no provisions in the Company’s debt obligations that would accelerate repayment of debt as a result of a change in creditratings or a material adverse change in the Company’s business.

their creditors will not foreclose them, ever. Apparently.

Matt

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Re: A look at MacDonalds NYSE:MCD

#231660

Postby TheMotorcycleBoy » June 24th, 2019, 10:13 am

From page 2 of https://corporate.mcdonalds.com/content ... d_Plan.pdf

Search for "Optimizing Capital Structure"

For where MCD sex up rationale for a huge amount of debt in order to buy back stock and maintain progressive dividend policy.

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Re: A look at MacDonalds NYSE:MCD

#231664

Postby TheMotorcycleBoy » June 24th, 2019, 10:23 am

Bizarrely Phil Oakley sings in praise of Maccy Ds here:

https://www.investorschronicle.co.uk/co ... appetites/

Notes the shift to franchising:

You can see that as a percentage of revenues, franchised restaurants are much more profitable than company-owned ones (which have all the operating costs). The significant change in mix towards franchises in recent years has seen total revenues decline, but has had a big impact on McDonald’s operating margin, which has increased from 29 per cent in 2015 to a very impressive 43.1 per cent in 2018.

Franchise revenues are now bigger than company-owned revenues. Not only has McDonald’s benefited from this shift in mix, but it has also been able to consistently grow its global like-for-like sales over the past few years. This is a very encouraging sign of a business that is keeping customers happy and attracting new ones.


He is keen to talk up the positives:

The growth in underlying revenues and shift in restaurant mix is feeding through to the company’s financial performance across a broad range of measures. More franchising is not only boosting profits, but it is also reducing the capital intensity of the business. Average capital invested has fallen by $5bn since 2014 while operating profits have increased by more than $1bn. Return on capital employed (ROCE) is currently a very impressive 33 per cent.

At the same time, there has been an increasing amount of investment in the business (more than its annual depreciation charge), which has been a drag on free cash flow (FCF). Yet FCF margins have increased to 20 per cent. When the investment in store remodelling and features such as digital menus and ordering, and improving the drive thru’ experience have finished (probably by 2022), then it’s not unreasonable to think that FCF margins could improve further.

The company is targeting like-for-like sales growth of 3-5 per cent over the next few years. Sales growth will also be helped by more restaurant openings (a net 750 more are expected in 2019) with a focus on emerging markets. McDonald's plans to sell more products, more quickly to existing and new customers. Areas such as breakfast and McCafe coffee are seen as attractive growth areas. Investment in improved store layouts and digital customer experiences (in-store menus and mobile apps) is part of a project called the 'Experience of the Future' and is also seen as a way of getting more people through the doors of its restaurants.


Only a single mention of the debt is made, and no mention of the negative equity is made anywhere in the article:

McDonald's has been buying back a lot of its own shares in recent years and has been prepared to take on more debt to do so. This should continue to support earnings per share (EPS) growth while keeping debt costs manageable.

What we are looking at here is the earnings yield a buyer of the shares would get over the next three years if current analysts’ forecasts are met. The projected yield would go from 4.6 per cent in 2019 to 5.3 per cent in 2021. That’s not particularly high, but those bullish on the shares would argue that compared with 10-year US Treasuries yielding 2.7 per cent currently, the outlook for McDonald's would suggest that shares remain reasonable value for a business of proven quality. I have some sympathy with that view.


I feel a little short-changed by his review.

Matt

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Re: A look at MacDonalds NYSE:MCD

#231673

Postby Dod101 » June 24th, 2019, 10:50 am

TheMotorcycleBoy wrote:So I've started to look at Maccy Ds. Got to fulfill Buffett's criteria of being a business that I can understand, right?

[However for MacDonalds we see two entries on page 26:

[1] Interest expense-net of capitalized interest of $15.5, $15.9 and $14.0	521.90 
[2] Nonoperating (income) expense, net 37.90

After some head-scratching (and looking around the rest of report) I believe their net interest position is: -559.8. (They owe the bank $559.8M).

I believe that entry [1] is always an expense, and the "net" bit means "includes" the 3 separate capitalized interest items. And I believe that [2] is to be interpreted thus:

If the following figure is parenthesised then this is income, hence positive, whereas if unadorned it's an expense i.e. negative.

Anyone got any opinions/comments on this?

thanks Matt


I admire your enthusiasm for going through these numbers. My take is that 'net of capitalized interest means, 'after capitalized interest has been deducted' The real interest expense is surely 567.3. I guess one question is why has any interest been capitalised (or capitalized in American lingo) ? Non operating expense may or may not have anything to do with interest from the quote you have provided.

Not much help in the overall scheme of things.

Dod

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Re: A look at MacDonalds NYSE:MCD

#231683

Postby TheMotorcycleBoy » June 24th, 2019, 11:29 am

Dod101 wrote:
TheMotorcycleBoy wrote:So I've started to look at Maccy Ds. Got to fulfill Buffett's criteria of being a business that I can understand, right?

[However for MacDonalds we see two entries on page 26:

[1] Interest expense-net of capitalized interest of $15.5, $15.9 and $14.0	521.90 
[2] Nonoperating (income) expense, net 37.90

After some head-scratching (and looking around the rest of report) I believe their net interest position is: -559.8. (They owe the bank $559.8M).

I believe that entry [1] is always an expense, and the "net" bit means "includes" the 3 separate capitalized interest items. And I believe that [2] is to be interpreted thus:

If the following figure is parenthesised then this is income, hence positive, whereas if unadorned it's an expense i.e. negative.

Anyone got any opinions/comments on this?

thanks Matt


I admire your enthusiasm for going through these numbers. My take is that 'net of capitalized interest means, 'after capitalized interest has been deducted' The real interest expense is surely 567.3. I guess one question is why has any interest been capitalised (or capitalized in American lingo) ? Non operating expense may or may not have anything to do with interest from the quote you have provided.

Not much help in the overall scheme of things.

Dod

I see what you mean. I suppose it could be either. I may do some more digging. However MCDs debt and -ve equity is somewhat off-putting.

Matt

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Re: A look at MacDonalds NYSE:MCD

#231684

Postby TheMotorcycleBoy » June 24th, 2019, 11:31 am


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Re: A look at MacDonalds NYSE:MCD

#231696

Postby SalvorHardin » June 24th, 2019, 12:05 pm

A word of caution about McDonald's negative equity. American accounting is very different from British accounting when it comes to valuing real estate (what the Brits call property but which should really be called "realty").

In an American balance sheet, property is valued at cost of construction (or purchase price) plus the cost of improvements minus accumulated depreciation as per the GAAP accounting standard. This routinely produce values which have nothing to do with market values, especially for older properties. Many other countries (e.g. Canada, Britain) use market value or some approximation such as implied value based on rents and capitalisation rate (as per IFRS).

McDonald's property and equipment as of 31st Dec 2018 was roughly $37.2 billion less $14.4 billion of accumulated depreciation, with total assets of $32.8 billion. Now whilst the depreciation on equipment is likely to be fairly accurate, the property is likely to be worth a lot more than its balance sheet value.

Anyway, for a major corporation concerns about its financial position will show up in the interest rates payable on its debt (and the eventual changes to its credit rating), probably well before the next balance sheet is produced.

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Re: A look at MacDonalds NYSE:MCD

#231712

Postby TheMotorcycleBoy » June 24th, 2019, 1:14 pm

SalvorHardin wrote:A word of caution about McDonald's negative equity. American accounting is very different from British accounting when it comes to valuing real estate (what the Brits call property but which should really be called "realty").

In an American balance sheet, property is valued at cost of construction (or purchase price) plus the cost of improvements minus accumulated depreciation as per the GAAP accounting standard. This routinely produce values which have nothing to do with market values, especially for older properties. Many other countries (e.g. Canada, Britain) use market value or some approximation such as implied value based on rents and capitalisation rate (as per IFRS).

McDonald's property and equipment as of 31st Dec 2018 was roughly $37.2 billion less $14.4 billion of accumulated depreciation, with total assets of $32.8 billion. Now whilst the depreciation on equipment is likely to be fairly accurate, the property is likely to be worth a lot more than its balance sheet value.

Anyway, for a major corporation concerns about its financial position will show up in the interest rates payable on its debt (and the eventual changes to its credit rating), probably well before the next balance sheet is produced.

Thanks Salvor,

I see what you mean. Since their 2015 rebirth plan they have bought and sold a lot of properties. So perhaps property valuation could be an issue.

However, in my opinion, MCD definitely steered themselves towards their current levels of debt. In the article I linked earlier they describe this part of their 2015 plan.

It's clear here in these lines I lifted from my earlier FA that the debt, number of shares and equity are linked.



Perhaps I should check another US fast food firm (KFC, TacoBell etc) as a comparison.

Matt

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Re: A look at MacDonalds NYSE:MCD

#231777

Postby TheMotorcycleBoy » June 24th, 2019, 5:14 pm

I am now more inclined to believe that MCD since they had been actively buying and selling a lot of purchasing in the period of interest (2013-2018) are stating their property assets reasonably well. They seem to be very quiet about their equity position now, I infer from previous statements regarding their RoE figures. If you look at page 25 of 2015's AR, being the last year of positive equity, (or just search for the string "total assets and returns"), you can see that for all years upto and including 2015, they make a point of publishing their RoE:

TOTAL ASSETS AND RETURNS
Total assets increased $3.7 billion or 11% in 2015. Excluding the
effect of changes in foreign currency exchange rates, total assets
increased $5.8 billion in 2015 primarily due to higher cash and
equivalents. Nearly 75% of total assets were in the U.S.,
International Lead markets and High Growth markets at year-end
2015. Net property and equipment decreased $1.4 billion in 2015,
primarily due to the impact of depreciation and foreign currency
translation, partly offset by capital expenditures, and represented
about 60% of total assets at year end.
Operating income is used to compute return on average
assets, while net income is used to calculate return on average
common equity. Month-end balances are used to compute both
average assets and average common equity.


Returns on assets and equity


But for in 2016's AR - the first year of negative equity, this time page 24, the RoE is conspicuous by it's absence:

TOTAL ASSETS AND RETURNS
Total assets decreased $6.9 billion or 18% in 2016 primarily due to
lower cash and equivalents. Nearly 85% of total assets were in the
U.S., International Lead markets and High Growth markets at
year-end 2016. Net property and equipment decreased $1.9 billion
in 2016, primarily due to the impact of depreciation and the reclass
of the assets of China, Hong Kong, and Taiwan markets to assets
of businesses held for sale, partly offset by capital expenditures.
Net property and equipment represented about 70% of total
assets at year end.
Operating income and month-end asset balances are used to
compute return on average assets. For the years ended 2016,
2015 and 2014, return on average assets was 23.0%, 20.9% and
21.8%, respectively.


I would believe that if they were in a genuinely positive position then they would be more inclined to address their property valuation, in order to could continue to report a strong RoE as in the past.

Matt

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Re: A look at MacDonalds NYSE:MCD

#231793

Postby TheMotorcycleBoy » June 24th, 2019, 5:46 pm

I have done some CAGR calculations (and verified by looking at Maccy quarterly filings) and note that they reduced their outstanding shares at a rate of about 5% per year since 2013. They slowing down (the reduction from Mar 2018 to Mar 2019 is by 3% https://corporate.mcdonalds.com/content ... form8k.pdf). I'm suspicious that most of the EPS and FCFps is due to this activity is all off the back of their indebtness.

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Re: A look at MacDonalds NYSE:MCD

#231811

Postby TheMotorcycleBoy » June 24th, 2019, 7:07 pm

"Finally" I looked at doing some Intrinsic value calculations using DCF and EPV. All my calculations suggest the market seriously overvalues Maccys at currently about $203.

These are my estimates:

From upto AR2018 (31 dec 2018) Discount rate = 9.02% inflation rate=2.7%         |       |                         
| |
DCF with annual growth of 2.7% forever | 66.91 |
DCF with annual growth of 3.7% (CAGR of 2016-2018s FCFps) for 10, then 2.7% | 72.15 |
DCF with annual growth 6% for 5, then 4% for 5, then 2.7 (seems unrealistic) | 80.41 |
DCF with annual growth 15% for 5, then 6% for 5, then 2.7 (insanely far-fetched) | 124.8 | (see SimplyWallStreet*)
| |
EPV with 25% of SDA added back @24.2% tax | 82.39 |
EPV with 25% of SDA added back @27% tax | 78.72 |


The entry annotated (see SimplyWallStreet*) is my attempt at arriving SimplyWallSt.s estimate of $136. Even this suggesting overvaluation by market.

The reason why SWS valuation is a lot higher than is:
1. their "analysts" seem to predict phenomenal growth rates (much higher than my CAGRs on figures across 3,4,5 year periods)
2. they use "Levered FCF", which seems plain silly, because that (if I understand things corrected is cash flow, without the interest charge being deducted).

FWIW On the SWS page there's a link called "raw data" below their DCF value. If you click it, you get a bunch of words and numbers and you can reverse engineer how they get their values.

This is their "raw data", sorry it's hard to read. I didn't have time to pretty the tabs etc. :ugeek:

Code: Select all

Below are the data sources, inputs and calculation used to determine the intrinsic value for McDonald's.                                                                                       
NYSE:MCD Discounted Cash Flow Data SourcesData Point                                                                                         | Source                                                                   | Value                           
Valuation Model                                                                                         |                                                                          | 2 Stage Free Cash Flow to Equity
Levered Free Cash Flow                                                                                         | Average of 26 Analyst Estimates (S&P Global)                             | See below                       
Discount Rate (Cost of Equity)                                                                                         | See below                                                                |                             9.2%
Perpetual Growth Rate                                                                                         | 10-Year US Government Bond Rate                                          |                             2.7%
                                                                                       
An important part of a discounted cash flow is the discount rate, below we explain how it has been calculated.                                                                                       
Calculation of Discount Rate/ Cost of Equity for NYSE:MCDData Point                                                                                         | Calculation/ Source                                                      | Result                         
Risk-Free Rate                                                                                         | 10-Year US Govt Bond Rate                                                |                             2.7%
Equity Risk Premium                                                                                         | S&P Global                                                               |                             6.0%
Hospitality Unlevered Beta                                                                                         | Simply Wall St/ S&P Global                                               |                             0.92
Re-levered Beta                                                                                         | = Unlevered beta (1 + (1- tax rate) (Debt/Equity))                     
= 0.924 (1 + (1 - 21.0%) (29.04%))                                                                                         |                                                                    1.091
Levered Beta                                                                                         | Levered Beta limited to 0.8 to 2.0                                     
(practical range for a stable firm)                                                                                         |                                                                     1.09
Discount Rate/ Cost of Equity                                                                                         | = Cost of Equity = Risk Free Rate + (Levered Beta * Equity Risk Premium)
= 2.73% + (1.091 * 5.96%)                                                                                         |                                                                    9.23%
                                                                                       
Discounted Cash Flow Calculation for NYSE:MCD using 2 Stage Free Cash Flow to Equity Model                                                                                       
                                                                                       
The calculations below outline how an intrinsic value for McDonald's is arrived at by discounting future cash flows to their present value using the 2 stage method. We use analyst's estimates of cash flows going forward 5 years for the 1st stage, the 2nd stage assumes the company grows at a stable rate into perpetuity.
NYSE:MCD DCF 1st Stage: Next 5 year cash flow forecast                                                                                         | Levered FCF (USD, Millions)                                              | Source                           | Present Value
Discounted (@ 9.23%)                                                                                       
                                                                                        2019 |                                                                 5,862.98 | Analyst x5                       |      5,367.42
                                                                                        2020 |                                                                 6,361.48 | Analyst x5                       |      5,331.54
                                                                                        2021 |                                                                 6,776.01 | Est @ 6.52%                      |      5,198.94
                                                                                        2022 |                                                                 7,140.58 | Est @ 5.38%                      |      5,015.59
                                                                                        2023 |                                                                    7,468 | Est @ 4.59%                      |      4,802.19
                                                                                        2024 |                                                                 7,768.86 | Est @ 4.03%                      |       4,573.4
                                                                                        2025 |                                                                 8,051.57 | Est @ 3.64%                      |      4,339.21
                                                                                        2026 |                                                                 8,322.62 | Est @ 3.37%                      |      4,106.17
                                                                                        2027 |                                                                  8,586.9 | Est @ 3.18%                      |      3,878.47
                                                                                        2028 |                                                                 8,848.09 | Est @ 3.04%                      |      3,658.65
Present value of next 5 years cash flows                                                                                         |                                                               $46,271.57
                                                                                       
NYSE:MCD DCF 2nd Stage: Terminal Value                                                                                         | Calculation                                                              | Result                         
Terminal Value                                                                                         | FCF2028 × (1 + g) ÷ (Discount Rate – g)                                 
= $8,848.092 x (1 + 2.73%) ÷ (9.23% - 2.73% )                                                                                         |                                                                 $139,781
Present Value of Terminal Value                                                                                         | = Terminal Value ÷ (1 + r)5                                             
$139,781 ÷ (1 + 9.23%)5                                                                                         |                                                                  $57,799
                                                                                       
NYSE:MCD Total Equity Value                                                                                         | Calculation                                                              | Result                         
Total Equity Value                                                                                         | = Present value of next 5 years cash flows + Terminal Value             
= $46,272 + $57,799                                                                                         |                                                                 $104,071
Equity Value per Share                                                                                       
(USD)                                                                                         | = Total value / Shares Outstanding                                     
= $104,071 / 764                                                                                         |                                                                   $136.3
NYSE:MCD Discount to Share Price                                                                                         | Calculation                                                              | Result                         
Value per share (USD)                                                                                         | From above.                                                              |                           $136.3
Current discount                                                                                         | Discount to share price of $204.26                                     
= -1 x ($204.26 - $136.3) / $136.3                                                                                         |                                                                   -49.9%
                                                                                       
Learn more about our DCF calculations in Simply Wall St’s analysis model.                                                                                       

Matt

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Re: A look at MacDonalds NYSE:MCD

#231812

Postby TheMotorcycleBoy » June 24th, 2019, 7:08 pm

Next thing for me to do is look at MCD state side competition e.g. Burger kings, Wendys, Yum, KFC, Dominos etc.

Matt

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Re: A look at MacDonalds NYSE:MCD

#232026

Postby BusyBumbleBee » June 25th, 2019, 7:11 pm

Well, Matt, you have certainly done your research. I have done mine from the other end and consider the firm investable for these reasons:

Their coffee is some of the best on the road and does not CostALot.
Their staff are always polite and helpful and there are usually some very good looking people acting as servers
The food is hot and quite tasty and nutritious too and easy to eat while driving
Customer throughput is immense and growing

Also they train their staff (especially school students and school leavers) very well and when I was recruiting for my IT businesses an ex MacD employee's CV was always moved to the "we should interview this applicant" pile

kind regards - BBB

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Re: A look at MacDonalds NYSE:MCD

#232030

Postby TheMotorcycleBoy » June 25th, 2019, 7:18 pm

BusyBumbleBee wrote:Well, Matt, you have certainly done your research. I have done mine from the other end and consider the firm investable for these reasons:

Their coffee is some of the best on the road and does not CostALot.
Their staff are always polite and helpful and there are usually some very good looking people acting as servers
The food is hot and quite tasty and nutritious too and easy to eat while driving
Customer throughput is immense and growing

Also they train their staff (especially school students and school leavers) very well and when I was recruiting for my IT businesses an ex MacD employee's CV was always moved to the "we should interview this applicant" pile

kind regards - BBB

Well I'm buying then!! :lol:

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Re: A look at MacDonalds NYSE:MCD

#232038

Postby YeeWo » June 25th, 2019, 7:37 pm

BusyBumbleBee wrote:Their coffee is some of the best on the road and does not CostALot.
Their staff are always polite and helpful and there are usually some very good looking people acting as servers
The food is hot and quite tasty and nutritious too and easy to eat while driving
Customer throughput is immense and growing
I agree with all of the above. McD is a fantastic business. The Self Ordering Machines and focus on nutritional information is far-and-away better than any other FNB operator. Strangely the first Automated McD I ever encountered was in Moscow, it took London a few years to catch-up with the Russian franchise operator seemingly!

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Re: A look at MacDonalds NYSE:MCD

#232083

Postby TheMotorcycleBoy » June 26th, 2019, 6:19 am

YeeWo wrote:
BusyBumbleBee wrote:Their coffee is some of the best on the road and does not CostALot.
Their staff are always polite and helpful and there are usually some very good looking people acting as servers
The food is hot and quite tasty and nutritious too and easy to eat while driving
Customer throughput is immense and growing
I agree with all of the above. McD is a fantastic business. The Self Ordering Machines and focus on nutritional information is far-and-away better than any other FNB operator. Strangely the first Automated McD I ever encountered was in Moscow, it took London a few years to catch-up with the Russian franchise operator seemingly!

I agree the business model and the brand is superb. But for me, the -ve equity, and the reason for the -ve equity really ruin the appeal.

Don't you find the fact they are piling on debt to maintain dividend and EPS scary?

Although I've not spent as much time as a top analyst with this (lots of other outlets for my time!), their growth in DPS and EPS looks like it's half funded by debt:


Will this turn nasty when Trump leaves office, and tax is raised and so too are fed rates?

Matt

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Re: A look at MacDonalds NYSE:MCD

#232091

Postby TheMotorcycleBoy » June 26th, 2019, 8:03 am

Just to qualify what I written in the thread that this is only my fundamental analysis. I'm MCD has been a great investment for many.

But with the current market valuation plus the bad things I've found on it's books, I think it would be crazy for me to open a position right now. It seems like this stock might see a "correction" in price sometime soon.

Matt


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