McDonald’s Stock: Past Five Years of Dividends

After I recently profiled IBM to examine one of the worst scenarios with a dividend growth investing strategy over the past five years, I thought I would take a look at another company that has fallen out of favor during the same period despite showing many of the characteristics of an excellent investment back in 2011. I’m talking, of course, about fast-food giant McDonald’s Corporation (MCD).

Back in 2011, the stock was on a roll. It had delivered 18% annual returns in the previous decade, 14.5% earnings growth, 17.5% dividend growth, was paying out a 3% dividend, was earning $5 billion in profits, only half were paying paid out as dividends, only had $12 billion in debt, and was sporting insane net margins in the 20% because of the lucrative contract arrangements with its franchisor-franchisee business model in which 83% of locations are independently owned and operated.

McDonald’s stock was on the short list of companies that could change your standard of living dramatically if you made a meaningful initial purchase and then left it be while you went through life. Buying $10,000 worth of McDonald’s stock in 1970 compounded at 17% through 2011 to grow into $5,700,000.

The attractiveness of the business model at McDonald’s is that it earns money passively without having to put in a whole lot of commensurate effort on its own. As a franchisor, it has continued Ray Kroc’s tradition of owning the premises and then charging the franchisee rent. It continues to earn a high single digit percentage on sales, making it partially isolated from the effects of higher food prices because it collects on revenues rather than profits. Interestingly, it has kept Ray Kroc’s pledge not to profit from the sale of food to its franchisees in the United States, but it has not kept this promise in international markets (one of my favorite cultural issues to study is when corporations accord moral-ish privileges to their operators in some countries but not others.)

Despite all these great attributes inherent in how McDonald’s generates its billion-dollar income streams, it has run into some limitations over the past five years.

First, it deals with the problems that nearly all companies earning tens of billions of dollars per year face–the inevitable saturation problem. There are almost 37,000 McDonald’s across the globe, with about half of them in the United States.

And second, it has to deal with the trends in favor of healthier eating options. Many of you have probably seen the recent news item suggesting that only out of five millennials have ever eaten a Big Mac at some point in their lives. That may be a number deserving scrutiny, as we have examined data in the past suggesting that the millennial generation feels shame about shopping at Wal-Mart and eating at McDonald’s so they understate the frequency of the experience in their interactions with pollsters. It’s the lifestyle version of the Bradley effect.

But even if the figure is understated, it still signals problems for McDonald’s. In 1987, only 23% of American adults went an entire month without eating at McDonald’s. Now, due to a combination of lifestyle changes and brutal competition in the industry (namely, more niche options) only 36% of Americans eat at McDonald’s in a given month. The numbers have almost flipped.

Despite these trends, I tend to have a more sanguine view of McDonald’s stock than most because: (1) it owns an extremely large real estate portfolio in highly attractive locations; (2) there are still 1 in 9 Americans that go there on a given day, so the base of support is there; and (3) investors aren’t really thinking about McDonald’s in proper counter-cyclical terms.

I’ll elaborate on that last point. There are certain companies that do well when recessions come around. For instance, the Daily Journal legal newspaper in Los Angeles, which is owned by Charlie Munger, makes its money by providing notice of foreclosures. Well, when are foreclosures going to be high? Right, during recessions. All the notice fees in the Daily Journal in 2008-2009 got used to purchase shares in Wells Fargo at $9 per share for shareholders of the Daily Journal.

Auto repair shops, Wal-Mart, and McDonald’s belong to that category that holds up well and experiences earnings growth during the bad times as people stop trading up. All things considered, you’re going to have a lot more McDonald’s visits in 2009 compared to 2016.

That part of the context is important to keep in mind when analyzing McDonald’s weak earnings growth figures from 2011 through 2016 in which earnings per share only climbed from $5.27 to $5.60. Economic upswings mean higher food prices and a customer base that is moving onto other fast food options but still expects you to keep your prices at a dollar.

McDonald’s itself paid out $18.84 per share in dividends from 2011 through 2016 (counting the 4Q payout.) The payout amount is $20.23 reinvested at an average price of $102.39 if you had spent the past years reinvesting. The net result is that each share of McDonald’s has grown into 1.1975 shares over the past half-decade.

The year 2011 saw wide variance in McDonald’s stock price–it traded as low as $72, and as high as $101. Someone who bought that year could have dramatically different outcomes.

If you paid $10,000 for 99 shares at $101 that grew into 118 shares at $115 each, you’d have a total value of $13,570. That’s 6.3% annual compounding.

If you paid $10,000 for 138 shares at $72 that grew into 165 shares at $115 each, you’d have $18,975. That’s 13.67% annual compounding.

When you review the past five years with McDonald’s stock, you should find yourself mulling over two lessons. The first is that price matters. A lot. You could have two investors that put up the exact same amount over nearly identical time periods for the same ownership stake in hamburger sales and rental income from it, and you’d have one so-so experience and another excellent experience. The second lesson is that, even in the worst case scenarios, reinvested dividends can still make a heck of a lot of difference. You might look at the current price of McDonald’s around $115 and compare it to the $101 price in 2011 and think “Meh. It basically stagnated.” But if you had been reinvesting, you’d be picking up almost 0.2 shares for each 1 share invested in 2011. Earning 6% annual returns when the initial buy-in time was the worst of the year and the subsequent five years proved disappointing is a credit to the strategy. This is an example of what I mean when I say that sticking with a large-cap holding for five years often cancels out much of the headline risk that plays games with emotions and valuations.

Originally posted 2016-10-16 17:43:17.

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