Dividend Aristocrats In Focus: McDonald’s Corporation

Updated on January 30th, 2023 by Felix Martinez

Every year, we review each of the 68 Dividend Aristocrats, the group of companies in the S&P 500 Index with 25+ consecutive years of dividend increases. We believe the Dividend Aristocrats are among the best stocks to buy and hold for the long run.

Broadly speaking, to make it on the list of Dividend Aristocrats, a company must possess a profitable business model with a valuable brand, global competitive advantages, and the ability to withstand recessions. This is why Dividend Aristocrats can continue to raise their dividends under challenging years, such as the 2020 coronavirus pandemic.

With this in mind, we have created a list of all 68 Dividend Aristocrats. You can download your free copy of the Dividend Aristocrats list, along with important financial metrics such as price-to-earnings ratios and dividend yields, by clicking on the link below:

McDonald’s Corporation (MCD) embodies all of the qualities inherent in a Dividend Aristocrat. McDonald’s paid its first dividend in 1976 and has increased it every year since. The company has now increased its dividend for more than four decades.

McDonald’s has implemented a successful turnaround in recent years through new menu offerings, remodeled restaurants, and accelerated investment in technology. These initiatives should help McDonald’s continue to raise its dividend for many years, although the stock appears to be overvalued today.

Business Overview

McDonald’s was founded in 1954 by Ray Kroc and his partners, Dick and Mac McDonald. Together, they formed the McDonald’s System Inc. In 1960, Kroc bought the exclusive rights to the McDonald’s name. Today, McDonald’s operates approximately 39,000 locations in more than 100 countries worldwide.

Revenues come primarily from franchise fees. McDonald’s has accelerated its franchising over the past several years. While this effort initially led to lower sales, it allowed McDonald’s to expand its profitability through higher margins. And with the franchising efforts lapped, McDonald’s is back to reporting impressive sales growth in addition to earnings growth.

On October 27th, 2022, McDonald’s reported its third-quarter results. For the third quarter, total revenue came in at $5.8 billion, representing a 5% decrease compared to Q3 2021. Revenue at company-owned restaurants was down 18%, while revenue from franchised restaurants –which have notably higher margins –increased by 5%. On an adjusted basis, earnings-per-share equaled $2.68 for the third quarter, compared to $2.86 in the same quarter a year ago.

For the nine months of 2022, the total revenues were down 10% compared to the same period in 2021. Again, sales from company-operated restaurants were down 10% year-over-year, while revenues from franchised restaurants were up 8% compared to the nine months of 2021. Net income saw a harsh decrease of 28% year-over-year. Thus, earnings per share for the nine months were also down 27% from $7.86 per share in 2021 to $5.75 per share in 2022.

Growth Prospects

McDonald’s performance has improved in the past few years due mainly to the strategic initiatives put in place to restore growth. These initiatives are working well and put McDonald’s in an excellent position to continue growing moving forward.

First, McDonald’s sees the potential to grow its unit count in the next few years.

Source: Investor Presentation

McDonald’s has plenty of additional catalysts for growth. McDonald’s announced new menu offerings, including all-day breakfast, which boosted sales significantly. A renewed focus on providing value to customers has also helped restore traffic. McDonald’s has also embraced technology in recent years by utilizing new technologies that help get food to customers faster.

For example, it has partnered with third-party delivery services such as Uber (UBER) Eats and GrubHub (GRUB), while it also recently acquired voice technology firm Apprente. Apprente makes artificial intelligence technology to provide faster and more accurate fulfillment of drive-through orders. McDonald’s has also rolled out mobile ordering and kiosks at many of its restaurants to simplify the ordering process even further.

This has helped McDonald’s post strong results in the United States. In 2021, comparable sales in the U.S. increased by 13.8%, which is the highest U.S. annual comparable sales ever reported and the seventh consecutive year of positive comparable sales.

We expect McDonald’s to generate 6% annual earnings-per-share growth over the next five years. This growth will be comprised of sales growth and share repurchases.

Competitive Advantages & Recession Performance

McDonald’s enjoys several competitive advantages that separate it from its industry peers. First, it is the largest publicly-traded fast-food company in the world. It has an enormous scale, which allows it to keep prices low. And it has one of the most valuable and widely-recognized brands worldwide.

One of the big reasons why McDonald’s continues to increase its dividend each year is because it has a defensive business model. When the economy takes a downturn, consumers tighten their belts, particularly when it comes to dining. Rather than go to higher-priced sit-down restaurants, consumers will often shift down to fast food during a recession.

From this perspective, McDonald’s actually benefits from recessions. For evidence of this, its earnings-per-share during the Great Recession are shown below:

2007 earnings-per-share of $2.91
2008 earnings-per-share of $3.67 (26% increase)
2009 earnings-per-share of $3.98 (8% increase)
2010 earnings-per-share of $4.60 (16% increase)

McDonald’s grew earnings each year of the recession at a double-digit compound annual rate. This is highly impressive and speaks to its recession-resistant business model. Investors can be reasonably assured the company can continue raising the dividend, even if another recession hits.

Valuation & Expected Returns

McDonald’s stock has generated huge returns in recent years. For example, in the past five years, McDonald’s stock generated total annualized returns of 21.8% per year. The only downside of this outstanding performance is that the stock now appears overvalued. Using the current share price of ~$270 and expected earnings-per-share for 2022 of $9.93, the stock has a price-to-earnings ratio of 27.2x earnings.

Over the past decade, shares of McDonald’s have held an average P/E ratio of 20x. We consider 20 times earnings as a reasonable, fair value estimate. If shares were to revert to a P/E valuation of 20, annual returns would be reduced by 5.8% through 2027.

Therefore, McDonald’s appears to be overvalued, based on relative comparisons to the broader market and its own historical average. Fortunately, the impact of overvaluation will be offset by earnings-per-share growth and dividends. In addition to the expected EPS growth of 6% per year through 2027, the stock also offers a current dividend yield of 2.2%.

Overall, McDonald’s is expected to generate total returns of just 2.4% per year, a weak projected rate of return. The relatively low expected return is due to McDonald’s stock valuation, which is abnormally high at the present time.

Final Thoughts

McDonald’s has paid a rising dividend for 47 years in a row. Over those four-and-a-half decades, it has had to reinvent itself from time to time to stay on top of changing trends in the restaurant industry. But it has consistently succeeded in its various turnarounds, a testament to the strength of its brand and business model.

It recently had to do this once again, but the results have been very encouraging. Last year was a great year for McDonald’s, which saw other industries and companies being impacted by the weak global economy. But a continuation of growth is likely for this industry leader in 2023.

That said, investors aren’t likely to see sizable gains with the stock’s high valuation. As a result, we believe investors should avoid the stock and wait for a pullback before buying McDonald’s.

If you are interested in finding high-quality dividend growth stocks suitable for long-term investment, the following Sure Dividend databases will be useful:

The major domestic stock market indices are another solid resource for finding investment ideas. Sure Dividend compiles the following stock market databases and updates them monthly: