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.
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 3.1%, considerably higher than the S&P 500's 2%.
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.
The payout ratio at McDonald's is a moderate 50%.
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.
McDonald's carries a moderately large debt-to-equity ratio of 97% but a comfortable interest coverage rate of 16 times.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
McDonald's has handled the global economic downturn remarkably well. All told, earnings per share have grown at a whopping annualized rate of 32% over the past five years as a result of growth in every region -- especially Europe -- while dividends have grown at a 22% rate. That's impressive for such a large company. For what it's worth, analysts do expect earnings growth to moderate to 10% over the coming years.
The Foolish bottom line
So, is McDonald's a dividend dynamo? It sure looks like it. The company has a large yield, a moderate payout ratio, manageable debt, and growth to boot.
If you're looking for some other great dividend stocks, check out "Secure Your Future With 9 Rock-Solid Dividend Stocks," a special report from The Motley Fool about some serious dividend dynamos. I invite you to grab a free copy to discover everything you need to know about the nine generous dividend payers.
The article McDonald's: Dividend Dynamo or Blowup? originally appeared on Fool.com.
Ilan Moscovitzdoesn't own shares of any company mentioned. You can follow him on Twitter,@TMFDada.Motley Fool newsletter serviceshave recommended buying shares of McDonald's. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days. The Motley Fool has adisclosure policy.
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