McDonald's: Dividend Dynamo or the Next Blowup?

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Dividend investing is a tried-and-true strategy for generating strong, steady returns in economies both good and bad. But as corporate America's slew of dividend cuts and suspensions over the past few years has demonstrated, it's not enough simply to buy a high yield. You also need to make sure those payouts are sustainable.

Let's examine how McDonald's (NYS: MCD) stacks up. In this series, we consider four critical factors investors should examine in every dividend stock. We'll then tie it all together to look at whether McDonald's is a dividend dynamo or a disaster in the making.

1. Yield
First and foremost, dividend investors like a large forward yield. But if a yield gets too high, it may reflect investors' doubts about the payout's sustainability. If investors had confidence in the stock, they'd be buying it, driving up the share price and shrinking the yield.

McDonald's yields 2.8%, a bit higher than the S&P 500's 2.1%.

2. Payout ratio
The payout ratio might be the most important metric for judging dividend sustainability. It compares the amount of money a company paid out in dividends last year to the earnings it generated. A ratio that's too high -- say, greater than 80% of earnings -- indicates that the company may be stretching to make payouts it can't afford, even when its dividend yield doesn't seem particularly high.

McDonald's has a safe payout ratio of 48%.

3. Balance sheet
The best dividend payers have the financial fortitude to fund growth and respond to whatever the economy and competitors throw at them. The interest coverage ratio indicates whether a company is having trouble meeting its interest payments -- any ratio less than 5 is a warning sign. Meanwhile, the debt-to-equity ratio is a good measure of a company's total debt burden.

Let's examine how McDonald's stacks up next to its peers:

Company

Debt-to-Equity Ratio

Interest Coverage

McDonald's94%17 times
Yum! Brands (NYS: YUM) 155%10 times
Wendy's (NYS: WEN) 68%2 times
Jack in the Box (NYS: JACK) 115%5 times

Source: S&P Capital IQ.

Restaurant chains can be a somewhat capital-intensive business. Each of these companies carries a decent chunk of debt. However, with the exception of Wendy's, they all seem to be able to comfortably handle their debt burdens.

4. Growth
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.

Let's examine how McDonald's stacks up next to its peers:

Company

5-Year Earnings-Per-Share Growth

5-Year Dividends-Per-Share Growth

McDonald's18%20%
Yum! Brands12%31%
Wendy'sN/A*(24%)
Jack in the Box2%0%

Source: S&P Capital IQ.
*Negative earnings.

McDonald's and Yum! are operationally in much better shape than Wendy's and Jack in the Box. They generate superior operating margins and have lots of exposure to fast-growing Asian markets.

The Foolish bottom line
McDonald's appears to be a dividend dynamo. It has a moderate yield, a modest payout ratio, a reasonable debt burden, and excellent long-term growth. If you're looking for some other great dividend stocks, I suggest you check out "Secure Your Future With 11 Rock-Solid Dividend Stocks," a special report from The Motley Fool about some serious dividend dynamos -- including McDonald's. I invite you to grab a free copy to discover everything you need to know about McDonald's payouts and the 10 other generous dividend payers.

At the time this article was published Ilan Moscovitzdoesn't own shares of any company mentioned.You can follow him on Twitter, where he goes by @TMFDada. The Motley Fool owns shares of Yum! Brands.Motley Fool newsletter serviceshave recommended buying shares of Yum! Brands and McDonald's. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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