I'm a McDonald's
More recently, the company has been reinvigorating the company's image with new initiatives like offering premium coffee drinks, remodeling stores, and focusing on the quality of its ingredients. And from a financial perspective, competitors like Wendy's/Arby's Group
And, of course, McDonald's treats its investors to one of my very favorite things in the whole world: a dividend. And not only is it a dividend, it's quite a nice dividend -- currently the yield on McDonald's stock is 3%, which is above what you can get from a 10-year Treasury note. Need more? The company's payout has grown 31% per year over the past five years.
But...
What was tempting to me was the idea that McDonald's could be a value based simply on its dividends. So I took a shot running a valuation on McDonald's using a dividend discount model.
Unfortunately, the results aren't terribly inspiring. While McDonald's dividend has grown by leaps and bounds in recent years, it'd be folly to predict that growth will continue at that rate because continued dividend growth well above the rate of earnings growth would bring the company's payout ratio to an unhealthy level.
Considering this, I assumed that payout growth would be 14% over the next decade. That's still pretty fast, but if the company is able to maintain 10% earnings growth, then the payout ratio shouldn't go beyond 75%. I further assumed that the perpetuity growth rate of the dividend is 4%.
Using a 12% discount rate, that brings McDonald's per-share value to roughly $56 -- not exactly what you want to see when the stock is trading at $74.
To be fair, I think you'd be hard pressed to find a reasonable valuation model that would show McDonald's to be vastly undervalued, but when I look at the shares with a cash flow- or earnings-based model, the result makes today's price look much more reasonable.
Dividend-only rock stars
Don't worry, there's nothing wrong with McDonald's or its dividends. Like many other strong, growing companies out there, McDonald's dividends will contribute to overall returns in the years to come and will likely help make the stock a good portfolio addition. But investors will have to look outside of dividends for part of their returns as well.
But are there companies out there that can stand on dividends alone? They're definitely tougher to come by, but they're out there. Here are a few that I was able to track down.
|
Company |
Dividend Yield |
Average Annual Five-Year Dividend Growth |
Payout Ratio |
|---|---|---|---|
|
Reynolds American |
6.4% |
13.3% |
102% |
|
Annaly Capital Management |
15.9% |
8.9% |
140% |
|
Energy Transfer Partners |
7.7% |
7.2% |
135% |
|
Maxim Integrated Products |
5.1% |
16.3% |
195% |
|
Senior Housing Properties Trust |
6.2% |
2.4% |
177% |
Source: Capital IQ, a division of Standard & Poor's.
Using a simple dividend discount model and trusting analysts' growth estimates (yes, I know that can be a dicey move), all of the stocks above could be considered good buys based on their dividend returns alone.
There are a few things we can highlight about these companies. Probably most obvious are the dividend yields. Annaly may be far and away the highest at 15%-plus, but 5% and 6% yields are nothing to sneeze at when investors have bid down 10-year Treasury yields to nearly half that.
For the most part, these are also all pretty stable, boring companies. Reynolds American is behind a slew of tobacco products including Camel and Pall Mall cigarettes, Energy Transfer Partners owns natural gas transportation and storage assets, and, as the name suggests, Senior Housing Properties owns properties like nursing homes and senior apartments.
And wary investors will also notice that the payout ratios are particularly high here. But it's this last point that makes these companies compelling based on their dividends alone -- these companies produce cash flow well above their accounting profits and focus on delivering most of that cash flow to investors. Maxim, for instance, paid dividends that were almost double its accounting profits over the past 12 months, but the company's free cash flow -- that is, cash from operations less capital expenditures -- of $367 million was more than enough to cover its $244 million in dividend payments.
Should you bite?
Annaly Capital has been quite the popular dividend stock lately, and I can see how a case could be made for it. But frankly, I'm not much of a fan of Annaly's business model and am lukewarm at best on the future stability of its dividend. That said, I think the rest of the group contains some pretty compelling plays for payout-hungry investors.
But it's also important to recognize what you're giving up as an investor with companies like this. Because most of the cash is being pumped out of the company, growth will likely be slower. For the same reason, the company may need to tap debt and equity markets more often when it does need capital. And the uncertainties over dividend taxation are even more worrisome when you're expecting most of your returns through dividends.
Investors focused primarily on current income will likely revel in these kinds of dividend-heavy plays. If you ask me though, I think these are best used as part of a diversified strategy, with more focus being put on companies that strike a balance between paying dividends and using cash to drive returns in other ways.
How do you protect your wealth from another recession? Would it surprise you if I said dividends?
