The Most Promising Dividends in Restaurants

Dividend payers deserve a berth in any long-term stock portfolio. But seemingly attractive dividend yields are not always as fetching as they may appear. Let's see which companies in the restaurant industry offer the most promising dividends.

Yields and growth rates and payout ratios, oh my!
Before we get to those companies, though, you should understand just why you'd want to own dividend payers. These stocks can contribute a huge chunk of growth to your portfolio in good times, and bolster it during market downturns.

As my colleague Matt Koppenheffer has noted: "Between 2000 and 2009, the average dividend-adjusted return on stocks with market caps above $5 billion and a trailing yield of 2.5% or better was a whopping 114%. Compare that to a 19% drop for the S&P 500."

When hunting for promising dividend payers, unsophisticated investors will often just look for the highest yields they can find. While these stocks will indeed pay out the most, the yield figures apply only for the current year. Extremely steep dividend yields can be precarious, and even solid ones are vulnerable to dividend cuts.

When evaluating a company's attractiveness in terms of its dividend, it's important to examine at least three factors:

1. The current yield
2. The dividend growth
3. The payout ratio

If a company has a middling dividend yield, but a history of increasing its payment substantially from year to year, it deserves extra consideration. A $3 dividend can become $7.80 in 10 years, if it grows at 10% annually. (It will top $20 after 20 years.) Thus, a 3% yield today may be more attractive than a 4% one, if the 3% company is rapidly increasing that dividend.

Next, consider the company's payout ratio, which reflects what percentage of income the company is spending on its dividend. In general, the lower the number, the better. A low payout ratio means there's plenty of room for generous dividend increases. It also means that much of the company's income remains in its hands, giving it a lot of flexibility. That money can fund the business's expansion, pay off debt, buy back shares, or even buy other companies. A steep payout ratio reflects little flexibility for the company, less room for dividend growth, and a stronger chance that if the company falls on hard times, it will have to reduce its dividend.

Peering into restaurants
Below, I've compiled the major dividend-paying players in the restaurant industry (and a few smaller outfits), ranked according to their dividend yields:

Data: Motley Fool CAPS. NM = not meaningful; P.F. Chang's and Tim Hortons started paying dividends less than five years ago, and Wendy's/Arby's posted a net loss for the most recent 12-month period.

If you focus on dividend yield alone, you might end up with McDonald's and Frisch's. In the case of Mickey D's, that wouldn't be so bad, but Frisch's dividend is growing much more slowly than that of the Golden Arches.

Instead, let's also focus on the dividend growth rate, where Darden and Yum! Brands lead the way, with McDonald's also strong. In addition, all of these companies have attractive payout ratios. Unfortunately, at 2%, Yum!'s dividend yield is a bit low. That's not necessarily a dealbreaker, but the ideal stock would have a higher yield as well.

Just right
As I see it, McDonald's and Darden Restaurants give you the best of everything for a dividend stock. They sport yields close to 3%, healthy dividend growth rates, and reasonable payout ratios. They all offer some solid income now and a good chance of strong dividend growth in the future.

Do your portfolio a favor. Don't ignore the growth you can gain from powerful dividend payers.