I think there’s a common misunderstanding around financial independence.
Some people think it’s an anti-work thing.
I don’t agree.
I think it’s a pro-optionality thing.
If one wants to work, that’s fantastic and they should have at it.
However, if one needs to work in order to put food on the table, that’s not a fun place to be in.
When thinking about how to achieve financial independence, I’d argue the very best way to get there is via dividend growth investing.
This is a long-term investment strategy whereby one buys and holds shares in world-class enterprises paying steadily rising cash dividends to shareholders.
You can find hundreds of businesses that qualify for this strategy by perusing the Dividend Champions, Contenders, and Challengers list – a source of rich information on US-listed stocks that have raised dividends each year for at least the last five consecutive years.
This strategy is so good at directing investors toward financial independence because it’s easy to slowly build enough passive dividend income to, over time, overcome one’s own expenses.
I’d know from personal experience, as I’ve used this strategy for more than 15 years now.
It’s helped me to build the FIRE Fund, which is my real-money portfolio generating enough five-figure passive dividend income for me to comfortably live off of.
This put me in the position to retire in my early 30s.
While the strategy naturally tends to funnel investors right into the world’s great businesses, it remains crucial to be vigilant regarding valuation.
And that’s because price is only what you pay, but it’s value that you get.
An undervalued dividend growth stock should provide a higher yield, greater long-term total return potential, and reduced risk.
This is relative to what the same stock might otherwise provide if it were fairly valued or overvalued.
Price and yield are inversely correlated. All else equal, a lower price will result in a higher yield.
That higher yield correlates to greater long-term total return potential.
This is because total return is simply the total income earned from an investment – capital gain plus investment income – over a period of time.
Prospective investment income is boosted by the higher yield.
But capital gain is also given a possible boost via the “upside” between a lower price paid and higher estimated intrinsic value.
And that’s on top of whatever capital gain would ordinarily come about as a quality company naturally becomes worth more over time.
These dynamics should reduce risk.
Undervaluation introduces a margin of safety.
This is a “buffer” that protects the investor against unforeseen issues that could detrimentally lessen a company’s fair value.
It’s protection against the possible downside.
Steadily acquiring undervalued high-quality dividend growth stocks can be a highly effective way to achieve financial independence and open up optionality regarding work and all kinds of other aspects of life.
By the way, spotting undervaluation isn’t as challenging as it might seem.
Fellow contributor Dave Van Knapp’s Lesson 11: Valuation, which is part of a series of “lessons” designed to teach the dividend growth investing strategy, describes valuation using simple terminology and provides helpful tools toward this end.
With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…
McDonald’s Corp. (MCD)
McDonald’s Corp. (MCD) is an American multinational quick-service restaurant chain.
Founded in 1955, McDonald’s is now a $176 billion (by market cap) QSR leader employing approximately 150,000 people.
McDonald’s has more than 45,000 restaurants across 100+ countries.
Notably, the company controls most of the underlying real estate underpinning the physical stores.
An overwhelming percentage (95%) of these stores are then franchised, making McDonald’s primarily a generator of rent and fees.
The company reports results across three segments: International Operated Markets, 48% of FY 2025 sales; US, 41%; and International Developmental Licensed Markets & Corporate, 11%.
McDonald’s really needs no introduction.
By almost any meaningful measure, but especially in terms of annual revenue, this is the world’s largest QSR chain.
It’s become synonymous with American culture.
McDonald’s has been able to build such a massive and enduring business by sticking to the basics.
People have to eat.
And when it comes time to eat, price, value, speed, and taste are important measures for a lot of consumers.
If a company can deliver tasty food quickly and at a good value, it’s hard to imagine such a company not succeeding over time.
Well, McDonald’s has been able to do this at a world-leading scale, consistently generating growth across its revenue, profit, and dividend along the way.
Dividend Growth, Growth Rate, Payout Ratio and Yield
To that point, McDonald’s has increased its dividend for 51 consecutive years.
An incredible track record that makes McDonald’s a Dividend Aristocrat and a Dividend King.
It’s truly dividend royalty.
Against that backdrop, the 10-year dividend growth rate of 7.6% is made to be even more impressive since it started up after McDonald’s had already been consistently growing its dividend for four straight decades.
It’s one thing to crank out high-single-digit dividend growth off of a new and low base; it’s another thing altogether to do that after 40 years of delivering already.
That said, more recent dividend raises have been in a mid-single-digit range, as McDonald’s has had to adjust to unusual levels of inflation on the fly.
On top of the extremely consistent dividend growth, the stock offers a market-beating yield of 3.2%.
That’s about as high as the yield has been in at least a decade.
This yield is 100 basis points higher than its own five-year average, further putting the current situation into perspective.
However, this has come about due to a variety of factors, including consumer pressure and rising rates, not because the market is sniffing out some kind of danger regarding the dividend.
The payout ratio is at 62.7%, so there’s no issues whatsoever with the sustainability of the dividend.
In fact, McDonald’s just increased its dividend for the 51st consecutive year only days ago.
This is one of the best dividend profiles not only in the QSR space but the market as a whole.
Revenue and Earnings Growth
As true as that may be, though, this profile is largely composed of past data.
However, investors must always be anticipating future data, as today’s capital is risked for tomorrow’s rewards.
As such, I’ll now build out a forward-looking growth trajectory for the business, which will be of great aid during the valuation process.
I’ll first show you what the business has done over the last ten years in terms of its top-line and bottom-line growth.
And I’ll then reveal a professional prognostication for near-term profit growth.
Fusing the proven past with a future forecast in this manner should allow us to gauge where the business might be going from here.
McDonald’s moved its revenue from $24.6 billion in FY 2016 to $26.9 billion in FY 2025.
That’s a compound annual growth rate of 1%.
While that looks pretty awful on the surface, it’s very misleading.
McDonald’s aggressively carried out a refranchising effort over this period, taking its global franchise mix from about 80% to 95%.
More recent revenue growth out of McDonald’s has been in a mid-single-digit range.
Meanwhile, earnings per share rose from $5.44 to $11.95 over this period, which is a CAGR of 9.1%.
That’s more like it.
This is a more accurate reflection of the business’s actual economic output, although it’s probably overstating things a bit.
On top of margin expansion from the refranchising, McDonald’s reduced its outstanding share count by approximately 17% over this period.
Those two factors drove a lot of excess bottom-line growth.
Looking forward, CFRA believes that McDonald’s will deliver high-single-digit EPS growth over the near term.
CFRA has its 2027 adjusted EPS forecast pegged at $14.17, which implies a CAGR of nearly 8% between now and then.
CFRA notes that McDonald’s has peerless systemwide sales and operating margins, and its global store footprint easily beats any direct contender in the QSR space.
I’d also say that while switching costs are non-existent in the QSR space, McDonald’s has a fantastic app that encourages loyalty and repeat visits.
A capital-light franchise model supported by buybacks can easily get one to a HSD bottom-line growth rate on this kind of revenue base.
When you throw the 3%+ yield on top of that, that positions the shares to get to a 10%+ annualized total return (assuming a static valuation).
A multiple normalization can move things higher from there.
It’s a very nice setup on what is a defensive, stable, global business with some of the best brand power in the world.
Financial Position
Moving over to the balance sheet, McDonald’s has a good financial position.
The long-term debt/equity ratio is N/A due to negative common equity, while the interest coverage ratio is approximately 8.
The total long-term debt load of nearly $40 billion is not egregious for a company of this size.
McDonald’s also has investment-grade credit ratings of Baa1 from Moody’s and BBB+ from S&P.
It’s definitely far from a flawless balance sheet, but McDonald’s is not financially weak.
Profitability is very strong.
Again, due to negative common equity, there’s no meaningful ROE metric, but net margin has averaged 31.2% over the last five years.
ROIC is frequently close to 20%.
McDonald’s is generating fat margins and very high returns on capital.
Overall, McDonald’s remains a QSR juggernaut at the top of its game.
And with economies of scale, unrivaled brand recognition, global reach, peerless operational capabilities, and entrenched consumer mindshare and loyalty, the company does benefit from durable competitive advantages.
Of course, there are risks to consider.
Competition, regulation, and litigation are omnipresent risks in every industry.
The QSR space, in particular, is extremely competitive, although regulation and litigation are lesser risks.
Usage of GLP-1 weight-loss drugs are a rising risk, as these drugs can lead to less appetite for the types of foods that McDonald’s markets.
The company is exposed to volatile input costs, labor, exchange rates, and geopolitics.
A lack of switching costs adds to the competitive pressure.
Any kind of major economic slowdown would likely negatively impact the company, although the fact that it sells foods at low nominal price points helps to insulate it somewhat, as does the fact that it’s heavily franchised and stands to collect fees either way.
While there are some risks present, I see McDonald’s as a rather defensive investment.
And after a recent 30% drawdown in the stock, I think the valuation has become extremely defensible…
Valuation
The stock is now available for a P/E ratio of 19.4.
That’s well below the stock’s five-year average P/E ratio of 26.3.
The cash flow multiple of 15.7 is also far lower than its five-year average of 21.9.
And the yield, as noted earlier, is significantly higher than its own recent historical average.
So the stock looks cheap when looking at basic valuation metrics. But how cheap might it be? What would a rational estimate of intrinsic value look like?
I valued shares using a dividend discount model analysis.
I factored in a 10% discount rate and a long-term dividend growth rate of 7%.
I’m roughly extrapolating out the proven 10-year dividend growth rate into the future, although I’ve scaled it back slightly in order to account for recent slowing and the fact that McDonald’s is even larger and more mature than it was a decade ago.
McDonald’s has been very reliable and consistent regarding its dividend, already going on more than five straight decades of raising the dividend.
With a forecast for more high-single-digit EPS growth over the foreseeable future, I just don’t see why McDonald’s will suddenly start to break down and substantially break from its rich legacy.
The DDM analysis gives me a fair value of $275.35.
The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.
The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.
It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.
I find it to be a fairly accurate way to value dividend growth stocks.
The stock was probably a bit pricey earlier this year, but the recent drawdown appears to have overshot.
But we’ll now compare that valuation with where two professional stock analysis firms have come out at.
This adds balance, depth, and perspective to our conclusion.
Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.
1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.
Morningstar rates MCD as a 4-star stock, with a fair value estimate of $295.00.
CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.
They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.
CFRA rates MCD as a 4-star “BUY”, with a 12-month target price of $312.00.
I’m on the low side, but the range here isn’t large. Averaging the three numbers out gives us a final valuation of $294.12, which would indicate the stock is possibly 19% undervalued.
Bottom line: McDonald’s Corp. (MCD) is a global QSR juggernaut with unrivaled scale, reach, and brand power. The ingenious business model means the company is a rent and fee machine, generating fat margins and high returns on capital in the process. With a market-beating yield, high-single-digit dividend growth, a reasonable payout ratio, more than 50 consecutive years of dividend increases, and the potential that shares are 19% undervalued, this looks like the best time in years to accumulate shares of this Dividend King.
-Jason Fieber
Note from D&I: How safe is MCD‘s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 77. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, MCD’s dividend appears Safe with an unlikely risk of being cut. Learn more about Dividend Safety Scores here.
P.S. If you’d like access to my entire six-figure dividend growth stock portfolio, as well as stock trades I make with my own money, I’ve made all of that available exclusively through Patreon.
Disclosure: I’m long MCD.
