McDonald’s [MCD Trend] has been on my personal watch-list for quite a while now, but the price hasn’t come very close to my target buy price of $88 so it fell off my radar a bit. The other day I read an article in the Globe & Mail called “McDonald’s stock may yet regain its sizzle” by John Heinzl that sparked my interest. When I read his article it reminded me that McDonald’s is due for a dividend increase in about 2-3 weeks time, so it might be time to increase my target buy price and have another look at McDonald’s.
My target buy prices are based on a number of different factors, but I usually use dividend yield to tweak them to a reasonably conservative target. McDonald’s has been increasing its dividend for 38 years in a row, and in the past decade they’ve declared annual dividend increases in mid to late September. I’d wager this trend will continue. Here’s a look at the past 6 dividend increases:
McDonald’s is an internationally known restaurant chain that sells fast food across the world. This wide moat company has 5 and 10 year dividend growth rates of 13.9%1 and 22.8%1, and offers a dividend yield of 3.46% at the August 29, 2014 closing price of 93.72. Based on these numbers it is easy to understand why I’d be interested in this stock. While the 5 and 10 year dividend growth rates are impressive, they have been fuelled by an increasing payout ratio, as dividend growth has exceeded earnings growth over the past decade.
In 2004 the payout ratio was 28%2 and it is currently sitting around 60%2. I don’t expect McDonald’s to go too much above a 60% payout ratio, so future dividend growth will likely be limited to their earnings growth.
Over the next 3 to 5 years Valueline currently estimates annual growth rates of 7.0%2 and 8.0%2 for earnings and dividends. These rates; while not as high as prior years, are still good.
Yahoo! Finance has the annual earnings growth estimates at 6.16%3 for the next five years, which is around Valueline’s estimate. Based on these estimates I think it’s fair to say that over the next 5 years you could expect an average annual dividend growth rate around 6% to 10%, with my best guess likely somewhere in the middle around 8%. Trying to estimate dividend growth for 5 years accurately is a bit of a fool’s errand, but I like to go through the motions, to at least see that the 8% dividend growth I target in my holdings is at least likely. This lets me weed out no or low dividend growth stocks that don’t fit my investing philosophy.
McDonald’s September 2014 Expected Dividend Increase
John Heinzel mentioned in his “McDonald’s stock may yet regain its sizzle” article that “Bloomberg estimates that the next increase will be about 13 per cent.” McDonald’s has been going through some troubles lately with same-store sales flat or declining slightly. This coupled with the Chinese food safety concerns, the recent Russian stores closures, and the payout ratio hovering around 60% make me hesitant to expect a 13% dividend increase. While it’d be a nice surprise, I used a more conservative 5% dividend increase to tweak my target buy price from $88 to $93 ($88 x 1.05 = $92.40 rounded up to $93).
Valueline is estimating that in 2014 they will declare $3.282 in dividends. With 3 dividends already declared this year at $0.81 per quarter, it would appear they are estimating a 4.9% increase to $0.85 [3.28 – ($0.81 x 3)] per quarter.
Looking at David Fish’s US Dividend Champions list I can see that since 2000 the three lowest year over year dividend increases were 4.4%, 4.7% and 8.3%.
Between this table and the Valueline estimate I feel that a 5% dividend increase is a realistic increase to expect, with room to be pleasantly surprised. Past results can’t predict the future, but when it comes to dividends they can tilt the odds in your favor. Based on these factors I’m comfortable increasing my target buy price to $93 before the dividend increase is announced.
Why I bought shares
I bought shares on August 28, 2014 for an average price of $93.96 (trading fee included) in my taxable account. On September 5, 2014 I purchased some more shares in my RRSP with a bit of US money that was left in the account for an average price of $93.11. These are above my target price, but only slightly (~1%). I’m using the Smith Maneuver now which means I’m moving money from my line of credit to my broker account and logistically I’d rather be buying shares right away with this money so that the audit trail is clear. In the end, rather than waiting for the price to drop a bit more I chose to just buy the shares as I was eager to own a dividend growth stock of McDonald’s caliber.
Another important reason is obviously the price. Looking at the August 29, 2014 trailing twelve month (TTM) dividend yield chart below you can see that dividend yield is as high as it’s been since late 2009. This is a good indication that the share price is reasonably cheap, and with a dividend increase expected shortly the yield could be going even higher if the price stays the same.
I’ll get around to completing a full dividend stock analysis eventually, but in the meantime here are the bullets of why I bought these shares.
- Wide moat stock
- Long dividend streak of 38 years
- Dividend is sustainable (Payout ratio is around 60%)
- I expect long term dividend growth around 8%
- Strong financial strength (Valueline currently rates them A++2)
- Dividend yield is high for McDonald’s (Above 3.4%)
- They have consistently increased earnings year after year for the past decade.
- Current short term problems have brought the share price down to a reasonable price. I expect McDonald’s to rebound in the long term.
I get nervous buying in a market that has been going up for so long and seems to reach new highs every other day. When I hear words like “correction” thrown around I find it harder to buy shares, but I still do. For me it’s about the individual company not the market. In McDonald’s case the share price has actually come down over the past year and if there is a further significant drop in McDonald’s, then I’d likely just buy more shares.
I have to remind myself that I’m looking for great dividend growth companies with reasonably cheap valuations, not investing in the whole market. To find these companies at reasonable prices it often means buying during some short term crisis/problem that has spooked investors. In these situations a certain amount of nervousness is expected. With great companies opportunities like these don’t come around very often, which is why I decided to pull the trigger and buy McDonald’s.
1 7/31/2014 version of David Fish’s US Dividend Champions excel file. Link: http://dripinvesting.org/tools/tools.asp
2 August 29, 2014 ValueLine Summary of McDonald’s. Link: http://www3.valueline.com/dow30/f5707.pdf
3 Yahoo! Finance Analyst Estimates Page on August 29, 2014. Link: https://ca.finance.yahoo.com/q/ae?s=MCD
Photo credit: http://www.freedigitalphotos.net/
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