McDonald's: Yielding Value

10/07/2015 9:00 am EST

Focus: STOCKS

Kelley Wright

Managing Editor, Investment Quality Trends

If I had to choose just one factor as the key to investment success, it would be the ability to recognize and appreciate good value, explains Kelley Wright, editor of Investment Quality Trends.

We believe that the two most important measures of investment value are the dividend and the dividend yield.

Dividends are evidence of earnings; a rising dividend trend suggests a rising earnings trend; a rising dividend trend is a predictor for rising stock prices.

In our experience, high quality dividend paying stocks have repetitive patterns of high (Undervalue) and low (Overvalue) dividend yield.

To identify these patterns you must first compute the dividend yield over a decade or longer (15 to 25 years is optimum).

By example, one of the world’s most widely recognized brand names is that of McDonald’s (MCD).

Despite its history and status as the American icon company, McDonald’s struggled during the late 1990s and early 2000s.

Derided in some analytical corners as a relic of the past and a dying industry, McDonald’s in many ways epitomized the shift in consumer attitudes away from the old -school brick-and-mortar model to the new-school of hip-slick-and-cool, as represented by Starbucks.

In 2003, McDonald’s management decided it would not go quietly into the night and initiated a corporate strategy to put the luster back into the Golden Arches.

Part of the strategy was a commitment to shareholders to increase the value of their investment through a combination of share buybacks and dividend increases.

In 2002, McDonald’s dividend was $0.06 per quarter or $0.24 per year. By the end of 2003, the dividend had been increased by 60% to $0.10 a quarter or $0.40 per year.

The dividend has been consistently raised each year since and today the dividend is $.85 per quarter or $3.40 per year.

The first incremental dividend increase in 2003 put McDonald’s into our Undervalued area and our initial purchases were made at $15 and $19 per share respectively.

Today the stock is trading around $96 per share; a pretty hefty capital gain. More importantly, however, our initial dividend has increased over seven-fold.

Some no doubt are questioning why we haven’t sold this stock to harvest the gains. In our view, McDonald’s still represents historically good value due to the frequency and size of dividend increases.

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