There are a lot of things that one must consider
prior to buying stock in a publicly-traded company. Some of these
things include the strength of a company's business model,
geographic diversification, financial condition, valuation, and
Another important concern is the dividend that the
company in question pays out. Strength and sustainability of the
dividend are very important for dividend growth investors. In fact,
did you know that 42% of the total return of the S&P 500 over the
last 80+ years came from dividends? This is why dividends are so
important for any investment portfolio.
Today, let's dig into the fast-food restaurant sector and
check out the dividends from McDonald's and Yum Brands. We will
look into the dividend history of each company, its historical
dividend growth rates, whether or not each company's dividend is
supported by cash flows, and whether the companies can sustain their
dividend growth rates in the future.
When talking about a
company's dividend, the first thing that normally comes to mind is
the dividend yield, which is the percentage of your capital that you
receive in return over the next 12 months, as long as the dividend
amount is not changed. Here are the dividend yields from both
McDonald's and Yum Brands.
Table 1: Dividend Yields Of McDonald's and Yum Brands
McDonald's is the clear winner in this
category, with a dividend yield of 3.4%, well above the 2.0%
currently being offered by Yum Brands. It should also be mentioned
that the dividend yield of McDonald's is at its highest point since
December 2009, four years ago.
The dividend yield is just one of many factors that
need to be considered when it comes to the strength of a company's
dividend. A company's stock can have a high dividend yield due to an
unsustainable dividend payout ratio, or poor fundamentals that have
brought down the stock price. These items could then lead to a
dividend cut, which will reduce your yield on cost.
Dividend growth should also be considered. This is
because a company that increases its dividend payout every year
maintains the purchasing power of the income streams that are
received by its investors. If dividend growth rates can't keep up
with inflation, then investors are really losing money when they
consider the loss in purchasing power. Dividend increases also
signal a strong outlook by management and underscores their
commitment to shareholders. Many companies regard their dividends as
a sacred cow. Over time, dividend growth can supercharge an
investor's yield on cost. Consider Warren Buffett, who started
buying Coca-Cola back in the '80s. Now, he receives a yield on cost
of 40%, and growing every year as long as Coca-Cola keeps increasing
their payout. Sounds like a pretty good deal, no?
Let's see how the dividends of McDonald's and Yum
Brands have grown over the last 5 years. The numbers in the table
represent the average dividend growth rate over the last five years.
Table 2: Five-Year Dividend Growth Rates of
McDonald's and Yum Brands
Both of these companies have shown outstanding
dividend growth rates over the last five years, easily outpacing the
erosive effects of inflation. However, Yum Brands comes out
on top here with an average annual growth of more than 14%. Yum
Brands has increased its dividend every year for
the last 10 years. McDonald's has increased its dividend for 38 years straight.
We should also take note of the fact that while the
5-year dividend growth rate of McDonald's is north of 10%, the
company's most recent dividend increase was just 5.2%. The most
recent dividend increase of Yum Brands was 10.4%.
These strong dividend histories could not have happened
without each company's exceptionally strong business models and
brand strength. For right now, Yum Brands is the winner, when
looking at dividend growth over the last five years.
Dividend Payout Ratio
High dividend yields and strong growth rates are all
well and good, but we need to make sure that the company in question
is making enough money to keep the dividends going. This is where
the dividend payout ratio comes in. The payout ratio is the
percentage of the company's profits that get returned to
shareholders in the form of dividends. You usually like to see this
ratio at 60% or below, as that will insure that the dividends will
continue to get paid, even if the company experiences a downturn
over a short period. Dividend payout ratios that approach or exceed
100% may signal future dividend freezes or cuts, which are not good
at all for investors.
The table below shows the dividend payout ratios for
McDonald's and Yum Brands, both on a trailing twelve month and a
four-year average basis. The earnings that I used in these
calculations are referred to as core earnings, which remove one-time
items that don't have an impact on the company's operations.
Table 3: Dividend Payout Ratios of McDonald's and Yum
From the looks of Table 3, the dividend payments of
both McDonald's and Yum Brands are in very good shape. None of them
appear to be in any danger of getting cut. The current payout ratios
are a little bit above the four-year averages.
While both companies are looking very good in this
category, Yum Brands is just a little bit better here, with a
lower payout ratio, both on a trailing 12-month basis and a
4-year average basis. This means that Yum Brands is currently
showing more potential for dividend increases in the future. It
should also be noted that Yum Brands is targeting a payout ratio of
between 35% and 40% of earnings. This is also good, as this will
leave more money for the company to plow back into its business.
How About That Free Cash Flow?
A lot of folks would end their analysis after
calculating the dividend payout ratio. However, we need to keep in
mind that that figure is based on dividend payout as a percentage of
earnings, not actual cash that comes into the business over a
certain period of time. Earnings often contain items like
depreciation, asset impairments, actuarial gains on pension plans,
and other non-cash items that can distort the picture as to how
healthy a company's dividend really is. For this reason, I like to
calculate the free cash flow payout ratio, which shows us what
percentage of cash that comes in over a 12-month period gets
distributed to shareholders. This paints a more accurate picture
when it comes to the dividend safety of the company in question.
Table 4 shows how much of the free cash flows of
McDonald's and Yum Brands were paid out in dividends. Note that free
cash flow is calculated as operating cash flow, subtracted by
capital expenditures. Trailing 12-month and four-year average
figures are shown.
Table 4: Free Cash Flow Payout Ratios of McDonald's
and Yum Brands
Here, we see that the dividends that are currently
coming from each company are more than well-supported. With that
said, the current free cash flow payout ratio of McDonald's is a bit elevated.
With the free cash flow payout ratio in the 70% area,
I would expect to see the dividend growth of McDonald's continue to
moderate in the years
to come unless the company can show some growth in free cash
Yum Brands on the other hand, looks really good
here, with a lower free cash flow payout ratio that shows more
potential for dividend growth going forward.
When it comes to the free cash flow payout ratio,
Yum Brands is the winner here.
Any Ways To Predict Dividends Going Forward?
A lot of folks would end their analysis here,
especially after looking at the free cash flow payout ratios.
However, these figures are all based on what happened in the past.
We need to find some clues as to whether the company can continue
paying steadily increasing dividends in the future.
Interest Coverage Ratio
The interest coverage ratio illustrates the size of
the company's pre-tax profits relative to the company's interest
payments. Generally speaking, the more debt a company has, the more
interest it has to pay, and the less that the company has left over
to pay out dividends. The interest coverage ratio is calculated by
dividing the company's earnings before interest and taxes (EBIT) by
the company's interest payments made over the same period of time.
Low interest coverage ratios (usually below 2) generally show that
the company is having a hard time just trying to make its interest
payments. That may signal dividend cuts or eliminations in the
future. For this reason, we like to see high interest coverage
Table 5 shows the interest coverage ratios of
McDonald's and Yum Brands over the last 12 months.
Table 5: Interest Coverage Ratios of McDonald's and
Table 5 shows us that while Yum Brands was able
to cover its interest obligations more than 7 times last year,
McDonald's takes the cake, with an interest coverage ratio of almost
17. So, while both companies are excellent in this regard,
McDonald's steals the show.
Net Debt To Equity Ratio
The amount of debt that a company has can ultimately
influence the future direction of the company's dividend. Companies
that have more debt typically pay more in interest. It should also
be noted that at some point, the company's debt will need to be
repaid. While many companies are working around this by refinancing
the debt at low interest rates, this option might not be as
attractive when interest rates head back up. When the company
finally does extinguish its debt, it may have an adverse effect on
whether it can continue paying dividends.
The net debt to equity ratio can offer us some clues
as to how much of a problem debt will be when it comes to paying out
dividends. It is calculated by subtracting the company's cash
position from the company's short and long-term debts, and then
dividing that by the company's equity position. The lower this
ratio, the better it is for not only the company in question, but
for us as investors. Ratios under one are typically considered to be
Table 6: Net Debt To Equity Ratios of McDonald's and
Table 6 shows that while both of these two
companies look pretty good in this category, McDonald's gets the
Forecasted Earnings Per Share Growth
Dividend growth can be driven by a couple of
different factors. One of these factors is the expansion of the
company's payout ratio, where the company decides to pay out a
higher percentage of its earnings or free cash flow to shareholders
as dividends. However, you can only expand the payout ratio so much.
Eventually, you must have free cash flow growth in order to pay
steadily increasing dividends. And, we all know that free cash flow
growth comes from earnings growth. To get a good idea as to the
prospects of a company's future dividend payments, it may behoove us
to look at analyst projections for future earnings per share growth
over the next couple of years. Table 7 shows the forecasted earnings
per share growth rates for McDonald's and Yum Brands over the next
couple of years. These numbers come from the analysts at S&P Capital
Table 7: Forecasted Earnings Per Share Growth for
McDonald's and Yum Brands
Both McDonald's and Yum Brands are expected to post
solid earnings per share growth over the next couple
of years. However, Yum Brands is expected to grow earnings at a much
faster rate. This bodes very well for Yum Brands investors, as they
can continue to expect solid dividend increases in the future.
Meanwhile, shareholders of McDonald's should probably expect to see
mid single-digit dividend increases, similar to the one last year.
Today, we have looked at a number of different
factors in order to determine the strength and sustainability of the
dividends of McDonald's and Yum Brands. These factors include the
dividend yield, historical dividend growth rates, payout ratios,
interest coverage ratios, net debt to equity ratios, and analyst
projections for future earnings per share growth. After giving
careful consideration to all of these factors, we can conclude that
none of the dividends being paid by either of these companies appear
to be in any danger as of this writing.
While McDonald's has a higher
dividend yield and a better balance sheet, Yum Brands has
shown superior dividend growth over the last 5 years, and lower
payout ratios that indicate that there is plenty of room remaining
for more dividend increases. Yum Brands is also expected to post
much stronger earnings per share growth over the next few years. For
these reasons, investors in Yum Brands should continue to see robust
dividend growth going forward.
While the dividend of McDonald's is well-covered, a
average annual dividend growth rate will be hard to maintain with a
70% free cash flow payout ratio and expected earnings per share
growth of only 6-8%. I would expect the dividend growth of
be more on par with the 5% increase that we saw last year.
When it comes down to whose dividends are better, I'm
going with McDonald's. In spite of the fact that Yum Brands has
lower payout ratios and a higher dividend growth rate, the starting
yield is so low that if you extended the one-year dividend growth
rate of each company indefinitely, it would take at least 12 years
for the yield on cost of an investment in Yum Brands to surpass that
of an investment in McDonald's. And, the odds of Yum Brands
increasing its dividend by an average of 14% or more over the next
12 years are very slim. Then, you have to consider the cumulative
dividends that each investment would produce. It would take well
over 12 years for the cumulative dividends of an investment in Yum
Brands to surpass those of an investment in McDonald's.
Of course, before making a final decision between the
two, you must consider other items like valuation, product and
geographic diversification, and business models.