Can You Trust the McDonald's Dividend?

Mickey D's is a generous dividend-payer today, but the party might not last forever.

Anders Bylund
Anders Bylund
Feb 20, 2013 at 1:59PM
Markets

Income investors love stability. A rock-steady stock chart comes in handy if you ever find a reason to sell your cash-dispensing shares, but predictable dividends are where the real magic happens.

Today, I'll take a closer look at dividend hero McDonald's (NYSE:MCD). The fast-food king has absolutely crushed its peers in the Dow Jones Industrial Average (DJINDICES:^DJI) index over the last decade, and dividend payments have made a large difference along the way:

MCD Chart

MCD data by YCharts.

At today's prices and payouts, Mickey D's generous 3.3% yield tied with Microsoft (NASDAQ:MSFT) for the seventh-richest yield on the Dow. But can we expect McDonald's to keep paying these huge dividends?

Over the last four quarters, McDonald's generated $3.9 billion in free cash flows, of which $2.8 billion was returned to shareholders in the form of dividend checks, making for a 72% cash payout ratio.

You may call it a generous policy, but I find it a little scary. Many high-yield stocks support their payouts with a much smaller portion of their cash flows. For example, Microsoft put just 26% of its free cash into that 3.3% yield over the last year. That's a far more sustainable payout.

To put the current policy in a different perspective, McDonald's allocated just 25% of its free cash to dividends in 2003. Going back to that ratio would result in the Dow's second-lowest yield -- a meager 1.1%. Moreover, McDonald's has spent about $3 billion annually on share buybacks in the last six years. In other words, the company is dipping into the cash register to keep its shareholders happy.

McDonald's shareholders would be wise to keep an eye on this worrisome trend. It's not clear that the company can keep both dividends and buybacks this generous for much longer -- and investors hate to see dividend cuts. This market-beating chart could turn ugly in a hurry.