Fast-food giant McDonald's (NYSE:MCD) is universally known among dividend investors, and for good reason, since McDonald's has a long history of rewarding shareholders. McDonald's has paid a cash dividend since 1976 and has increased its payout every year since then. It kept the streak alive when it raised its dividend by 5% on Sept. 18.
McDonald's is a premier dividend stock, with a solid 3.6% dividend yield at recent closing prices. But there's more to McDonald's than the headline increase. Let's dig a little deeper to find out what McDonald's shareholders need to know right now.
Dividend growth, with a caveat
Fast food is a recession-resistant and highly profitable business. As a result, it's no surprise that companies like McDonald's and close rival Yum! Brands (NYSE:YUM) generate plenty of cash flow to pay regular dividends to shareholders. Yum! also recently raised its dividend, from $1.48 per share annually to $1.64 per share. That represents 11% growth, a solid increase that marks the 10th year in a row in which Yum! has delivered a double-digit percentage increase.
But even though McDonald's has a fantastic track record of increasing its dividend for years in a row, the rate of dividend growth has slowed significantly. For example, the company has raised its dividend by just 5% in each of the past two years, far below its historical average annual increases. From 2008 to 2012, McDonald's raised its dividend by 15% compounded annually.
That its dividend growth has slowed so much in the past few years underscores the challenges McDonald's faces. McDonald's has faced a number of problems over the past two years, which have dragged down its underlying financial results.
McDonald's sales were up just 2% through the first six months of the year; and its earnings per share are flat over the same period. In the U.S., management sees challenges that have resulted in negative guest traffic. Overseas, McDonald's ambitious growth plans, which were highlighted by aggressive new restaurant openings, got thrown off track by a recent food safety scandal in China.
As a result, financial results have gotten worse, not better, as the year has progressed. Global comparable-restaurant sales, which measure sales at restaurants open at least one year, fell 2.5% in July and 3.7% in August.
Nevertheless, McDonald's remains committed to returning a lot of cash to shareholders, even while its underlying business is struggling. McDonald's shareholders take those dividends very seriously, and McDonald's can accommodate them because it still generates significant free cash flow. According to its most recent quarterly 10-Q report, McDonald's generated $2.2 billion of free cash flow in the first six months of the year. The company paid $1.6 billion of dividends to shareholders through the first half, which is about a 71% payout ratio.
A modest increase is better than no increase
"Today's dividend increase reflects the continued strength and sustainability of our cash flow and our commitment to enhancing shareholder value," CEO Don Thompson said in a press release Sept. 18 announcing the new quarterly dividend of $0.85 per share.
While it's easy to be disappointed that McDonald's has delivered two very modest dividend increases for two years in a row, it's important to remember that investors are still being rewarded. Even a 5% dividend bump still outpaces inflation. Plus, McDonald's is also returning cash to investors via share buybacks. Even though McDonald's profits and share price have suffered, the share buybacks will create value for shareholders. As the share count is reduced, each remaining share becomes even more valuable.
The bottom line is that McDonald's pays a solid 3.6% dividend yield, which is one of the highest yields in the Dow Jones Industrial Average. McDonald's plans to turn things around include an aggressive expansion into new international markets, but in the meantime, the company still generates enough cash to raise its dividend, even though earnings growth is slowing. That in itself goes a long way in demonstrating the power of McDonald's and its dividend.
Bob Ciura owns shares of McDonald's. The Motley Fool recommends McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.