It’s easy to overlook a boring blue-chip stock in favor of a faster growing company. However, many investors make the mistake of assuming that a blue-chip company can’t provide superior returns.
This was the mistake that I made with McDonald’s Corporation (NYSE:MCD). I was more enamored with fast growing concepts like Buffalo Wild Wings (NASDAQ:BWLD), Chipotle Mexican Grill, Inc. (NYSE:CMG), and Panera Bread Co (NASDAQ:PNRA). I looked at McDonald’s expected growth rate of less than 10% as a waste of time, next to companies that might grow their earnings by 19% or 20% in the next few years. However, what I missed was the power of the company’s cash flow, and what a difference a good dividend makes.
Would You Like Two Ways to Make Money or Just One?
When you buy a growth stock, unless you are going to write options or make some other bet, you only make money if you sell the shares. When you buy a company that pays a dividend, you may make money when you sell the shares, but you also get paid even if the shares stay flat. If investors use dividend reinvestment, the change in their effective yield can be significant.
Five years ago, McDonald’s stock was selling for about $60 a share. At that time, the dividend yield was about 2.5%. In the last five years, the company has increased the dividend from an annual payout of $1.50 to $3.08. This means if you bought at $60, your effective yield is 5.13%. If you reinvested your dividends over that five year timeframe, your yield would be even higher. If your yield is already over 5% in the last five years, imagine what would happen if you bought 10 or 20 years ago.
The point is, a company with a growing dividend can provide both current income and potential capital gains. A company with no dividend can provide capital gains, or you could end up waiting around and losing money if the stock doesn’t go up.
This ‘Boring’ Business Makes a Lot of Money
In the restaurant industry, companies come and go, and yet McDonald’s finds new ways to grow. While the company’s current quarter earnings only showed diluted EPS up 4%, this was in a very difficult environment internationally. No matter what is going on, there are two things that McDonald’s does better than almost anyone.
First, McDonald’s has a gross margin that is the envy of most of the industry. In the current quarter, the company’s gross margin was 39.24%. The only company in its peer group to perform better was Starbucks Corporation (NASDAQ:SBUX) with a gross margin of 57.35%. However, the fact that Starbucks is known for its upscale coffee offerings, and McDonald’s is known for its dollar menu makes this comparison a bit unfair.