Investing in stocks is a wonderful way to build wealth.
Think of all the great investors you’ve ever heard of: Warren Buffett, Peter Lynch, and Benjamin Graham are just a few you might have come across.
These guys didn’t make their fortune by putting cash in a savings account or a CD. And while many had some allocation to fixed income at some point in their careers, the bulk of their wealth was built via equities.
When investing in stocks, you have to remember that these are real-life businesses.
And why wouldn’t you want to invest in extremely successful businesses that have been around for decades, providing the products and/or services that make the world go ’round?
I hear of people sometimes buying stocks simply to trade in and out, hoping to make a quick buck.
I couldn’t more strongly recommend against this kind of behavior!
Buying stock is buying a tiny sliver of a real business.
Thus, you wouldn’t head to your local downtown and buy a piece of the worst business in town, would you?
Of course not.
You’d want a piece of the best business in town, and you’d want a regular piece (your fair share) of the profit.
That’s why I invest in dividend growth stocks.
These are real businesses that have often been in business for many decades, providing essential products and/or services to the world. And they can prove their profitability via regular dividend “checks”. Better yet, these “checks” are routinely growing year in and year out.
Don’t tell me how great business is going.
Show me.
These businesses can show me the “proof in the pudding” – that profit is real – via bigger and bigger dividend checks every single year, because these companies are, collectively, the backbone of the world’s economy. As such, it doesn’t really matter what’s going on.
Political news?
Interest rates?
Weather catastrophes?
Nope, doesn’t matter.
People still have to put gas in their car. People still have to eat food and drink beverages. People still have to buy medicine. People still have to brush their teeth.
So on and so forth.
Holding high-quality dividend growth stocks for the long term grows your wealth as a shareholder because you’re able to not only capture the appreciating nature of their shares as the businesses become more valuable over time, but you’re also able to receive and reinvest more and more dividend income over time, which then provides you an additional source of fresh capital to buy even more equity.
A company like McDonald’s Corporation (MCD), which I own in my personal stock portfolio, is a great example.
Founded in 1948, it’s now the largest fast-food restaurant company in the entire world, with over 36,000 restaurants in over 100 countries.
You want a Big Mac and those legendary fries?
Well, then you’ll have to go to McDonald’s for it. And that’s what millions of people across the entire world do every single day.
As a shareholder and a customer, I get the best of both worlds. I can enjoy a Big Mac just like everyone else, but it tastes that much better when I know I’m contributing to my own bottom line (as I’ll end up collecting a very small slice of my own purchase via the growing dividends McDonald’s is paying me).
Look, the world is moving faster and faster, and people are on the go more than ever. And McDonald’s serves these mobile consumers with good food at a fair price all hours of the day and night.
This customer loyalty is a good reason the company has grown so much.
Over the last ten fiscal years, earnings per share are up from $1.98 to $5.44. That’s a compound annual growth rate of 11.88%, which is very impressive.
Revenue, though, is roughly stagnant over this time period, up from $22.786 billion to $24.622 billion. That’s a CAGR of just 0.86%.
However, bottom-line growth is much more important than top-line growth. After all, you’d rather sell $1 million worth of goods and profit $200,000 than sell $2 million worth of goods and lose money.
In regard to McDonald’s, they’ve been actively refranchising. This presents a more predictable business model, with reliable cash flow and higher margins.
And the company has also bought back a lot of stock over the last decade, cutting up profit across less shareholders.
It’s been a rough 10-year stretch for a lot of businesses. The financial crisis and the ensuing Great Recession didn’t do any business any favors.
However, McDonald’s still booked strong growth in profit.
That’s because no matter what happens to the economy, people need to eat. And a recession means people are looking to eat even cheaper.
McDonald’s knows this and offers food at multiple price points, of which their value offerings at lower price points are particularly popular.
Similar growth appears to be on the horizon. Professional analysis firm CFRA predicts that McDonald’s will compound its EPS at a 10% annual rate over the next three years.
But what is really impressive is the dividend growth McDonald’s has been able to deliver for shareholders for decades.
The company has boosted its quarterly dividend for 42 consecutive years.
Just think of all that’s happened over the last 42 years. Yet McDonald’s kept on delivering ever-larger dividends to their shareholders.
The company has a 10-year dividend growth rate of 13.7%.
And with a dividend payout accounts for only 58.3% of profit, there’s still plenty of room for further dividend growth moving forward.
This company’s standing as a Dividend Champion in David Fish’s Dividend Champions, Contenders, and Challengers list is unlikely to be challenged anytime soon.
I know I’ll keep doing my part with my own occasional visits to my local McDonald’s.
Meanwhile, a yield of 2.4% is relatively attractive and healthy in this market.
And the company has been open about its intentions to continue rewarding shareholders. McDonald’s recently announced its plan to return $22 billion to $24 billion to shareholders (via share repurchases and dividends) over the next three years.
Profitability is robust, as one might expect for a dominant franchise.
The company has averaged net margin of 18.8% over the last five years.
Investors just love to see net margin well into the double digits like this.
And the company’s ability to meet its interest expense obligations is healthy, with the company sporting an interest coverage ratio of almost 9.
McDonald’s has spent the last few years re-imaging restaurants across their entire portfolio, which modernizes their restaurants and creates a better atmosphere for customers who eat in the stores. Some of these changes also include greater drive-thru capacity.
This leads to not only greater customer retention and satisfaction, but also a greater chance of cross-selling. And they’re doing this while simultaneously opening new restaurants across the entire world.
In addition, MCD continues to focus on bringing changes to the menu that make sense, as they focus on four prime categories for the greatest growth potential: beef, chicken, breakfast, and beverages.
New initiatives like all-day breakfast and newly-released specialty burgers have only helped bolster same-store sales growth.
You know what this means?
More and better locations to sell more and better products.
And you know what selling more and better products means?
More dividend increases to shareholders.
And McDonald’s doesn’t have to rely only on new products and more stores to increase profit over time.
Think about this: the Big Mac was introduced in 1967, selling for just 45 cents. That iconic cheeseburger doesn’t sell for that much anymore, does it? That’s due to pricing power and inflation. McDonald’s is able to keep up with inflation and raise their prices over time, and customers keep coming back because of the products, value, and service they provide.
Another fantastic aspect of their business is that most of their restaurants are franchised (which is only increasing as the company refranchises), meaning franchisees run the day-to-day operations and provide McDonald’s as a corporation a steady, recurring source of revenue.
Shares are selling at a price-to-earnings ratio of 24.7.
That seems a bit high, even in this market. Indeed, the five-year average P/E ratio for the stock is 19.7. Investors are paying up for McDonald’s stock right now. Perhaps they’re paying up too much.
I used a dividend discount model analysis to value shares.
I factored in a 10% discount rate and a long-term dividend growth rate of 7%.
That long-term DGR factors in the company’s historical bottom-line growth, long-term and near-term demonstrated dividend growth, a fairly moderate payout ratio, and the forecast for near-term profit growth.
The DDM analysis gives me a fair value of $144.09.
Bottom line: McDonald’s Corporation (MCD) is a company that’s been rewarding shareholders with increasing dividends for more than four decades now, on the back of rising profit from selling food to billions of customers all over the world. And since the world is increasingly mobile and people have to eat, McDonald’s is about as sure a bet as any stock out there. The only problem is, given its current overvaluation, the stock is just too expensive to buy today. Even the highest-quality companies aren’t worth any price, and so one would be prudent to wait for a pullback that brings shares closer to fair value.
Good investing!
Jason Fieber
Note from DTA: If you’re looking for a high-quality dividend growth stock you can buy today, then check out this video Jason recently recorded from his apartment in Chiang Mai, Thailand. In short, you’ll watch over Jason’s shoulder as he analyzes a high-quality dividend growth stock that pays a near 3% yield and appears undervalued at current prices. This stock could be one of the best dividend growth opportunities available today…