Seeking Alpha
Long-term horizon, portfolio strategy, bonds, dividend investing
Profile| Send Message|
( followers)  

In a recent article I looked at the 2012 performance of my ETF skimming adventure where I take the top ten holdings from Vanguard's Dividend Appreciation ETF (NYSEARCA:VIG) and examine the performance on total return and dividend growth metrics. I call this portfolio the Scaredy Cat Vanguard Dividend Appreciation Portfolio or SCVIG. To be included into the ETF a company will have had to have raised its dividend for 10 straight years, and get a passing grade on other value metrics.

The Top Ten or SCVIG delivered a very impressive outperform from its inception due to the large cap bias.

The SVIG has had an incredible run from its inception in May of 2006. SCVIG has delivered an 85% total return to October 2012 (when I posted the first SCVIG article) compared to a 23% return for the S&P 500 (NYSEARCA:SPY) and compared to a 35% return for the total holdings of VIG. That's a very significant outperformance due largely from SCVIG's large cap bias that allowed it to stand quite well during the roller-coaster ride of 2008 to 2009.

But last year was a different story.

For 2012, SCVIG scratched out a 7.3% total return while the S&P Dividend ETF (NYSEARCA:SDY) delivered 11.6%, the S&P 500 delivered 16%, and the Dow Jones Industrial Average (NYSEARCA:DIA) delivered a 9.9% total return. The total holdings for VIG delivered 11.1% total return.

The reason? SCVIG was slowed by too much fast food. Too many fries and Big Mac's. McDonald's (NYSE:MCD) had an off year. In fact, McD's lost 9% in 2012. It had some choppy and slowing earnings and revenue. But this fast food giant is still a Dividend Growth stalwart. Not only that, McDonald's has delivered on the total return front. An investor would have seen a 428% total return from the beginning of 1997.

But McDonald's investors would have seen some lean years over those long-term salad days. In fact, from early 1999 to the beginning of 2007 McDonald's showed a zero return on price. Factor in dividends for that 8 year period and McDonald's offered a 29% total return. That's a 3.23% annualized rate of return. It beat inflation, barely.

Purchasing McDonald's in the period of 1998-2001 you would have had to watch your holdings drop in value by some 50-70% (from your purchase prices) to early 2003. That may not appear to be an extensive time period on a long-term chart, but 4-5 years can seem like forever to an investor who is under water and watching their company face even more cruelty from the market. And there is very little help over that 4-5 year period from dividends, and even increasing dividends. Dividend growth rates are a long-term offer, and the best they have to offer is delivered from the 10-20 year periods, especially when an investor is battling unusual market volatility - or the current secular bear market.

The lesson that McDonald's delivers to investors is one of the greatest lessons of all - most investment strategies take time - lots of time. 10-15 years. Especially when an investor decides to use a strategy that overweights equities, or in the case of many dividend growth investors, is invested almost entirely in dividend growth stocks. If you run calculations for income growth and total return growth of dividend growth stocks or ETFs, you'll find that the real magic occurs after 10 years, and it gets really silly (in your favour) from 15-20 years.

A dividend growth investor may not have had any buzzers going off to tell him or her to sell McDonald's. If the main parameter for inclusion into their portfolio is a growing dividend supported by income and a manageable payout ratio, McDonald's would likely get a check, check and a check.

McDonald's is on David Fish's Dividend Aristocrats list, having raised its dividend every year for some 25 years. From 2002, McDonald's has grown its dividend at a rate (OTCPK:CAGR) of 30%. From 2006 to present the CAGR dropped to 20.4%. The last three years have seen 26%, 10% and 12% dividend increases. McDonald's flips burgers but it seems to make increasing dividends more than anything else. If now offers a current yield just over 3%.

It is one of the strongest brands on the planet. See my article on how brand strength leads to powerful earnings growth. One of my favourite commercials of all time shows a Dad and a daughter taking the training wheels off of her bike in "First Ride". The little girl finally finds her balance and takes off down the road, she doesn't turn back, she just keeps on riding. Her Dad is concerned and asks where she's going. She squeals with childlike delight "McDooonnaaalllddddsss!!!" So true. Any parent knows that a young toddler, while a passenger in the back of your car, will point to the Golden Arches as you pass, wondering why you are not stopping for some delicious golden and crispy French fries with ketchup (that they can smear all over their face and outfit). We get hooked early.

But McDonald's has offered periods where it has tested investors' faith and patience.

Here's a headline from Fortune Magazine in 2002

Fallen Arches McDonald's has had six straight earnings disappointments. Its stock is down 42%. And we can't even remember the jingle! What happened?

Wow, sounding the death knell for McDonald's. That seems like a spectacular overstatement in hindsight, but those are the headlines an investor would have been reading back in 2002. Even Warren Buffett sold his stake in MCD.

Here's more from that article:

"Sizzling-hot Wendy's, which recently upped its earnings guidance for the rest of the year, has soared 57%.Tricon Global, which owns KFC, Pizza Hut, and Taco Bell, just hit a new 52-week high, with the stock up 65% for the year. Shares of McDonald's, meanwhile, have inched up less than 4% from last April. And at $28, the stock is off 42% from its 1999 high".

McDonald's was having its lunch handed to it. Same store sales growth had grinded to a snail's pace. But mostly, McDonald's suffered from failed expansion plans in foreign and developing markets and some operational missteps.

Earnings per share grew just 4% and revenues 7%, on average, in each of the past five years, looking back from 2002. McDonald's was no longer a high-test growth stock. It likely became a dividend growth stock , supported by slower earnings growth.

But here are the more recent numbers …

McDonald's Corporation

Year 2011 2010 2009 2008 2007
Total Revenue $27,006 $24,075 $22,745 $23,522 $22,787
Net Income $5,503 $4,946 $4,551 $4,313 $2,395
Depreciation $1,415 $1,276 $1,216 $1,208 $1,214
Amortization $0 $0 $0 $0 $0
Capital Expenditures ($2,730) ($2,136) ($1,952) ($2,136) ($1,947)
# of Shares 1044.9 1080.3 1107.4 1146 1211.8
Earnings $4,188 $4,087 $3,815 $3,385 $1,663
Owner Earnings per Share $4.01 $3.78 $3.45 $2.95 $1.37
Owner Earnings / Revenue 15.5 % 17.0 % 16.8 % 14.4 % 7.3 %

Things are looking "solid" for McDonald's in my opinion. I don't know if I would have had the guts or patience to stand by the fast food giant. McDonald's was not just suffering due to the overall market conditions, MCD was an underperformer against the market and its peers.


(Click to enlarge)

Above we can see the Golden Arches doing more dipping than arching, charted against the S&P 500. Here is how patient investors would have been rewarded from January of 1999. All comparisons beginning in 1999, total return including reinvested dividends. Total return numbers are thanks to the incredible tools at low-risk-investing.com.

  • 5 Years to end of 2003. Negative 32% return.
  • 7 years to end of 2005. Negative 4% return.
  • 10 years to end of 2008. 91% total return.
  • 14 years to end of 2012. 208% total return.

From 1999 to present, through the tech market meltdown, through recovery, through the real estate bubble collapse and market meltdown of 2008-2009, to present, a patient investor would have realized an annualized total return of 8.4%. Thanks to a strong brand that allowed McDonald's to continually increase its dividends. That outperforms the market (S&P 500) that offered a 2.8% annualized total return over the same period. Patience and loyalty was certainly rewarded. And if one had held McDonald's for 20 years, they would have been served a very healthy 640% total return.

McDonald's is certainly in its golden years, but can it still deliver? I'll let you know after I finish my Egg McMuffin and hash browns.

Source: McDonald's: Fast Food Requires Investor Patience