I’ve been studying McDonald’s this morning and checking out how the terms are different for the folks that buy shares of the stock compared to the early 2000s when the starting dividend yield was under 1% (of course, McDonald’s was an awesome investment for everyone who bought the stock in 2001, as it has returned 12% annually since then, turning $10,000 into $45,398).
But when you invested back then, you needed the substantial growth to happen—you weren’t going to rely on the dividend yielding less than 1% to be a substantial part of your returns.
Here in 2014, McDonald’s investors are working from a higher base, such that even if you only get moderate growth from the dividend, you’re still getting significant downside protection.
All an illustration: Right now, McDonald’s is sending out $0.81 to owners every three months for every share they get attached to their name. At an annual rate of $3.24, McDonald’s is returning 55-60% of its yearly profits to owners in the form of a cash dividend.
What if that dividend only grows at 6.5% annually, in line with pessimistic projections about the company and with the assumption that sales don’t grow because the customers that were alienated by $1.29 cheeseburgers instead of $1 cheeseburgers don’t eventually say, “ahh, screw it” and come back?
You would have a situation like this:
McDonald’s pays dividends at a rate of $3.24 in 2014.
McDonald’s pays dividends at a rate of $3.45 in 2015.
A $3.67 rate in 2016.
A $3.91 rate in 2017.
A $4.16 rate in 2018.
A $4.43 rate in 2019.
A $4.72 rate in 2020.
Really, we’re interested in the 2015-2020 pull because most of 2014 has already happened and McDonald’s has made four payments of $0.81 in a row (after this September 16th payout), meaning that in late September that should be an announcement of a dividend raise that would take place in time for the December payment.
For someone that’s been sitting on the stock throughout 2014, there is a good chance that he or she is going to collect at least $27.58 in total dividend income between now and 2020. At a price of $93 per share, that’s a huge facilitator—you stand a reasonable probably of collecting 25-30% of your initial investment back over the next six years from dividends alone, using estimates that are on the conservative side of realistic. You get a 10% or 12% bump early on in the cycle, and the numbers will be much better because the base rate going forward would be higher.
I suspect that, five or so years from now, people will look back upon McDonald’s yielding 3.5% the same way that they look back on Johnson & Johnson yielding over 4% a few years ago, IBM yielding over 2.5% not that long ago, or BP yielding over 5.5% a year or two ago.
Imagine if those $27.58 in dividends got reinvested at an average price of $125 per share between now and 2020. You would have a situation where someone owning 500 shares bought at $94 each would be adding 110 shares to his overall count. It’s not just the $4.72 you’d be collecting in 2020; with reinvested dividends, you’d have an extra 110 shares that got automatically created collecting $4.72. In that case, you’d be collecting $2,880 each year, for a 6.12% yield-on-cost at the end of the six-year mark. And if things work out better than expected (e.g. the recent slow sales growth is temporary and people are just applying recency bias to their future calculations), then this is one of those situations where you’ll be collecting at least $0.10 in annual dividend income a decade from now if you automatically reinvest each dividend payment along the way, leveraging those forty opportunities to increase your share count.