It pays a higher yield than the wider market and is on sale right now.
The rallying market has lifted the valuation of dividend stocks in 2024 while simultaneously lowering their yields. Those trends have made it harder for income investors to find attractive values. The S&P 500, which is packed with quality dividend payers, jumped 21% through late September and yields just 1.3 %.
Dividend investors can do better than that.
There’s one member of that index that’s priced at about the same level it was when 2024 began. Its stock is currently paying a 2.3% yield as well. Sure, the business is going through a tough time right now as shoppers spend more cautiously on fast food. But patient investors should still do well by holding McDonald’s (MCD 0.10%) stock over the long term. Here’s why.
Soggy fries
McDonald’s gave investors heartburn in its last few earnings reports, which showed stress on the leading fast-food business. Guest traffic declined in the second quarter, management revealed in late July, leading to a rare drop in comparable-store sales (comps).
That’s not exactly a surprise. Customer traffic had been slowing for several quarters but was offset by the chain’s higher prices in 2023. The price-inflation lift seems to be over, though, which has Wall Street worried about what will spark the next growth cycle.
Management has added to those worries by describing a challenging sales environment. “Consumers are more discriminating with their spend,” CEO Chris Kempczinski said in a late-July press release.
Investors still seem to be overreacting to the 2024 slowdown. Keep in mind that McDonald’s posted soaring growth a year ago, with comps rising 12% in the second quarter. The latest 1% drop isn’t as distressing in that context. The company generates lots of revenue from franchise fees, rent, and royalties, helping explain how consolidated sales are still setting records even as guest counts decline.
The finances
And you’ll have a hard time finding many businesses that are as financially strong as McDonald’s. The burger slinger generated $4.1 billion of operating cash flow in the first six months of 2024, translating into 32% of sales. Profit margin landed at a blazing 45% of sales in the period, down just slightly from the record high of 45.5% in mid-2023.
As you might expect, Mickey D’s dividend is well covered by those ample earnings, meaning investors can count on the payout rising, just as it has in each of the last 48 years. The chain is now within striking distance of joining the exclusive club of Dividend Kings (companies that have raised dividends annually for 50 or more consecutive years).
In the meantime, it’s possible the stock will struggle with weaker returns, at least until trends in sales growth speed back up. McDonald’s has plenty of levers it can pull in that regard, including by bulking up its value offerings and launching more limited-time offers. It dominates in the drive-thru segment that has become more popular with fast-food fans, and its home-delivery platform can boost sales as well.
Investors can take advantage of the pessimism around this business to grab McDonald’s shares at an attractive price. The stock is valued at 26 times earnings, or about half of Chipotle‘s valuation. It’s true that McDonald’s doesn’t have nearly the momentum that the Tex-Mex chain enjoys today. However, there’s a good chance it will return to its more-normal growth cadence over the next several quarters.
In the meantime, investors can collect a solid dividend that’s backed up by some of the strongest profits in the fast-food industry. That’s a recipe for excellent long-term returns from here.
Demitri Kalogeropoulos has positions in Chipotle Mexican Grill and McDonald’s. The Motley Fool has positions in and recommends Chipotle Mexican Grill. The Motley Fool recommends the following options: short September 2024 $52 puts on Chipotle Mexican Grill. The Motley Fool has a disclosure policy.
