The Power of McDonald’s Corporation (MCD)’s Dividends

The fact that McDonald’s Corporation (NYSE:MCD) is a relatively consistent business has led the company to make consistent dividend payments and payment increases annually for many years. The company has raised the dividend every year since first paying one in 1976. McDonald’s increased its dividend payments annually by at least 10% in 9 out of the last 10 years, with the average increase of nearly 30% over the time period. With the average pay raise for working Americans at only 3% in 2013, McDonald’s dividend investors are getting the better deal in terms of annual raises.

The dividend story

McDonald’s Corporation (NYSE:MCD) currently pays a dividend of $3.08 per share, for a yield of 3%. The five year average dividend yield was 3.2%. As a comparison, the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) pays a dividend of just 2.03%. The 1% dividend edge that McDonald’s has over the S&P 500 does add up over the long-term.

The power of McDonald’s dividends lies in the consistent annual increases, which contributes to a significant compounding effect when dividends are reinvested. For example, a $10,000 investment in McDonald’s Corporation (NYSE:MCD) will grow to be worth about $15,000 in five years without reinvesting dividends. However, if dividends were reinvested, the position would be worth over $17,000 in five years. I am using the five-year expected earnings growth rate of 8.7% in the calculation, as stock prices tend to rise at a similar pace to earnings growth over the long-term.

The effect is more dramatic when looking further into the future. The same $10,000 investment should be worth about $23,000 in ten years without reinvesting the dividends. If dividends are reinvested, the $10,000 should be worth over $30,000 in ten years. That’s 30% more gained in ten years by reinvesting the dividends.

Stability

Another thing to keep in mind is the stability of McDonald’s Corporation (NYSE:MCD) business. It’s a simple fact of life that everyone needs to eat. With an extensive footprint of stores in the U.S. and elsewhere, it is usually not difficult to run into a McDonald’s restaurant on your way to or from work. McDonald’s is about the convenience of grabbing that cup of coffee in the morning with an Egg McMuffin. It’s about contractors and other mobile workers getting lunch at a reasonable price. It’s also about parents getting in a quick meal after work before heading to their kids sporting events. It’s about the kids convincing their parents to treat them to a McDonald’s meal so that they can get their hands on the latest Happy Meal toy. The convenience is there in the number of stores dotting the landscape. The consistency is there with the company’s identical product quality across all of its restaurants. This convenience and consistency gives McDonald’s a stable business with little downside risk.

Competition

The current risk that McDonald’s Corporation (NYSE:MCD) now faces is competition. Yum! Brands, Inc. (NYSE:YUM) has been expanding in many of the same countries that McDonald’s has expanded into. YUM! Brands’ Taco Bell, KFC, and Pizza Hut restaurants have their place in the restaurant industry. Yum! Brands has a lower gross margin of 27% as compared to McDonald’s gross margin of 39%. Yum! Brands’ dividend yields only 1.9%, as compared to McDonald’s 3.1% yield.

McDonald’s Corporation (NYSE:MCD) needs to remain vigilant about maintaining customer loyalty by giving people a reason to return to their restaurants regularly. McDonald’s breakfast menu is a definite plus; that gives the company an edge over the competition. McDonald’s premium coffee and other McCafe items get folks in the restaurant or drive-thrus in the early morning hours when other restaurants don’t operate.

However, Dunkin Brands Group Inc (NASDAQ:DNKN) does compete directly with McDonald’s on breakfast offerings. Dunkin’ Brands does have a nice gross margin of 79%, but the dividend only yields 1.9%. McDonald’s needs to maintain an updated menu to keep up with consumer’s changing tastes and to maintain an edge over the competitors such as Dunkin’ Brands. McDonald’s has done a great job with this thus far with new menu offerings and seasonal items.

It is important to note that Yum! Brands, Inc. (NYSE:YUM) and Dunkin’ are more geared towards growth than as a higher dividend paying company like McDonald’s Corporation (NYSE:MCD). Although Yum! and Dunkin’ pay lower dividends, they have a higher expected annual growth than McDonald’s. Yum! and Dunkin Brands Group Inc (NASDAQ:DNKN)’ are expected to grow earnings annually at 11.7% and 15.6% respectively as compared to McDonald’s growth of 8.8%.

Valuation

McDonald’s has maintained a fair valuation as its business is relatively predictable without too many significant surprises. The company is valued a little higher than the S&P 500, with a forward PE of 16, a PEG of 2.04, and a price to book ratio of 6.72. However, this is a typical valuation for a relatively predictable business.

Conclusion

McDonald’s has performed well over long periods of time. The company typically bounces back from bumps in the road as experienced in the under-performing 2012, when the stock lagged the market. The stock is now back above $100 and in vogue with investors. With its extensive and growing global restaurant footprint, consistently rising dividends, large economies of scale, and ability to adapt to changing consumer tastes, I’m confident that McDonald’s Corporation (NYSE:MCD) will continue to be a winning investment over time.

David Zanoni owns shares of McDonald’s. The Motley Fool recommends McDonald’s. The Motley Fool owns shares of McDonald’s.

The article The Attractive Power of McDonald’s Dividends originally appeared on Fool.com.

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