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:

• The current yield
• The dividend growth
• 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 some of the major dividend-paying players in the restaurant industry (and a few smaller outfits), ranked according to their dividend yields:

Source: Motley Fool CAPS. 

Dividend investors typically focus first on yield. Darden Restaurants tops the chart here, but it's not necessarily your best bet. The company cut back its 2013 projections and is not getting any love for favoring part-time workers in order to reduce health-care costs. Wendy's (NASDAQ: WEN), meanwhile, may have an appealing dividend yield, but its five-year dividend growth rate is negative. It's true that it recently doubled its payout, but the dividend is still below 2008 levels. The company has been struggling with tough competition, significant debt, and low profit margins.

Instead, let's focus on the dividend growth rate first, where several companies sport five-year average annual dividend growth rates of more than 15%. Such rates are so steep, though, that they may be hard to maintain for long. Fortunately, most have reasonable payout ratios, making that less of an immediate concern. It's worth looking more closely at each company's growth, too. McDonald's (NYSE: MCD), for example, has been slowing  down its dividend growth rate, though its revenue and earnings growth rates have been rising. The company has been innovating successfully, threatening rivals as it introduced smoothies, gourmet coffee, and healthier fare such as oatmeal. It has plenty of room for growth remaining, especially abroad.

Another way to play the company's global expansion is through Arcos Dorados (NYSE: ARCO), the largest franchiser of McDonald's restaurants in the world, and one focused on Latin America. It has been growing briskly, but has been challenged by some regional economic policies.

Some restaurant companies, such as Chipotle Mexican Grill (NYSE: CMG) and Krispy Kreme Doughnuts (NYSE: KKD), don't pay dividends at all. That's because smaller or fast-growing companies often prefer to plow any excess cash into further growth, rather than pay it out to shareholders. Chipotle is not that small, with a market cap recently above $9 billion, but it's still in a rapid growth phase, with five-year average annual growth rates  of 19% and 34%, respectively, for revenue and earnings. The company has a lot of room for growth and has seen its stock slump some this past year, making its valuation more attractive.

Krispy Kreme has struggled over much of the past decade, but started posting profits in the past few years and recently hit a 52-week high. Some speculate that it might get bought  out, but even if it isn't, the company has been performing well, recently opened its 500th international store, and seems attractively valued.

Just right
As I see it, McDonald's offer the best combination of dividend traits, sporting some significant income now and a good chance of solid dividend growth in the future. It's worth looking into some other restaurant companies, too, such as those without dividend increase histories yet. Arcos Dorados, for example, has a lot going for it. Yum! Brands, too, is a strong player in the field.

Of course, as with all stocks, you'll want to look into more than just a company's dividend situation before making a purchase decision. Still, these stocks' compelling dividends make them great places to start your search, particularly if you're excited by the prospects for this industry.