Dividend increases are almost always an encouraging sign. However, one caveat that investors should keep in mind is the trajectory of dividend growth. A company that increases its dividend routinely at double-digit percentage rates for years on end, and then significantly reduces its dividend growth rate, may be providing a warning sign about future business troubles.
That's exactly what's happening in the case of fast food giant McDonald's (NYSE:MCD), which had provided investors double-digit dividend growth for the past several years. This year's dividend increase was only 5%, much less than many investors had probably expected. As a result, many shareholders may be questioning what McDonald's is trying to signal to its investors.
Was McDonald's dividend increase simply a matter of conservative management? Or is there more meat to this story than the market realizes?
Past as prologue
Indeed, there's plenty of historical precedent to suggest that McDonald's most recent dividend raise is cause for concern. Consider that the company's dividend increase was far less than the regular annual increases announced over the past several years. From 2007 to 2012, McDonald's had increased its dividend by 15% compounded annually.
There's also reason for disappointment based on how industry competitors are rewarding their own shareholders. Fellow fast food juggernaut Yum! Brands (NYSE:YUM), which owns and operates the KFC, Taco Bell, and Pizza Hut chains, recently announced a 10% dividend increase. This marks the ninth year in a row in which Yum! has given investors a double-digit percentage dividend boost.
Note that Yum!'s dividend is still playing catch-up to McDonald's. Prior to its dividend raise, Yum! yielded just 1.9%. McDonald's yields 3.3%, so Yum! will have to keep growing its payout at very high rates just to catch up to McDonald's yield. In fact, Yum! would have to raise its dividend by 10% per year for the next five years to yield 3.3% based on where it currently trades.
Another important consideration is that many fast food peers simply don't pay dividends at all. Two smaller industry competitors, Jack in the Box (NASDAQ:JACK) and Sonic Corp. (NASDAQ:SONC), don't offer their investors the volatility-reducing, guaranteed return of regular dividend payments. Neither stock pays a dividend; both Jack in the Box and Sonic have decided that the best use of cash flow is to reinvest in their companies, to keep growing their respective businesses.
The tactic makes sense, as both Jack in the Box and Sonic are tiny industry players when compared to McDonald's. Both stocks hold market capitalizations of just $1 billion each, so using cash to expand and open new locations is likely the best tactic.
The verdict is in: stick by McDonald's
In the end, I see McDonald's decision to raise the dividend by only 5% as a matter of management being cautious, perhaps overly so, in light of the still-difficult operating environment. Consumer discretionary companies such as McDonald's, which rely heavily on the health of the consumer, are seeing business conditions toughen as consumers pinch pennies.
It's easy to squabble with McDonald's decision to reduce its pace of dividend growth, but a 5% increase is still good enough to indicate that business should be fine going forward. Also, a 5% increase is still greater than the rate of inflation, meaning investors' purchasing power is being protected (and actually, improved) in real terms.
To be fair, McDonald's has such an impressive track record of providing shareholder returns, through not just dividends but also share buybacks, that I believe the company should be given some leeway. McDonald's has increased its dividend every year since its first dividend payment in 1976, and also returns billions to shareholders every year in the form of share repurchases.
As a result, while I would pay closer attention to its underlying earnings results in the quarters ahead to ensure that this isn't a broader problem, I'm inclined to give McDonald's the benefit of the doubt. It remains one of the highest-quality dividend stocks out there, and I have no plans to sell any time soon.
Bob Ciura owns shares of McDonald's. The Motley Fool recommends McDonald's. The Motley Fool owns shares of McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.