McDonald's (NYSE:MCD) is a company that is near and dear to my heart as I have worked at the store level for about four years now, and I've been lovin' it. While working within the store over the past four years, I've noticed that other than increasing our operational efficiency, not much has changed. The customers still flood us with business, the food is pretty much the same, and although I've worked in three different stores with many different people (turnover can be high), the employees are pretty much the same. Many people are aware that McDonald's is a well run company, and it is, so I decided to look into how McDonald's success translates into success for the shareholders. The purpose of this article is to illustrate the value McDonald's dividend provides to investors through reinvestment, and at the end of the article, I provide a valuation on the stock given certain assumptions about growth, which I will outline.
Analyzing the Dividend
If you take a look at McDonald's current quarterly dividend, it stands at 81 cents. Using the current stock price as of June 18, 2014, ($101.00), we can see that the annual yield comes out to be 3.21%. This may not be as enticing as some other companies out there; however, it's important to note this dividend to stable. Since November 2007, McDonald's has consistently paid out a dividend every quarter, and, raised that dividend every year by varying amounts. Based on the analysis of another Seeking Alpha contributor, McDonald's has a stable payout ratio, and will very likely continue to pay and raise its dividends.
That said, if we assume that the dividend will constantly grow at 5% per year. If we reinvest the dividends through purchasing more McDonald's stock over the course of five years, we can earn a 20.14% return through the dividend payments alone. Below, Figure 1 represents the math that brought me to this conclusion. My assumptions were that share price would remain constant, dividends would grow at 5% annually, and the investor would purchase nine shares of the company. The reason I didn't include share price appreciation in this model is simply because I wanted to focus on the return that McDonald's dividend provides investors. The 5% growth rate is an assumption built from last year's dividend adjustment, and going forward I assume the company will continue to increase the dividend by this proportion.
Source: Created by the author.
If we now annualize this return, we can see that the yield of the dividend after reinvesting it rises to 3.74% per year. This is because when investors reinvest the dividends in the stock, they receive more payouts per quarter because they own more shares after each payout, leading to a compounding effect. It is important to understand that this yield changes as the stock price varies over time, improving if the price decreases and weakening if the price increases. Regardless, it is easy to see how reinvesting the dividend can provide an advantage to any buy and hold investor.
Gordon Growth Valuation
The Gordon Growth Model is a valuation tool that is used to find the intrinsic share price value of slower-growing, mature companies using a constant dividend growth rate and constant share price growth rate.
Here I will perform a valuation of McDonald's using the Gordon Growth Model. The assumptions built into this valuation will be defined as 5% dividend growth (G). Required rate of return for the equity investor will be 5.75% (K). I came up with 5.75% because the average annual return for McDonald's over the past two years has been 7.25%, and to be conservative, I shaved off 1.5% to account for a slower growth pace. Under these observations, 5.75% seems like a reasonable number to me. (D) will be 5% higher than the current dividend, 85 cents. Figure 3 below outlines my calculations.
Source: Created by the author.
After crunching the numbers, we come up with a share price of $113.33. This indicates that according to the Gordon Growth Model, the shares are trading at a 12.21% discount relative to the current share price on June 18, 2014, of $101.00.
What this tells us is that in addition to a higher, stable dividend yield, the shares are also trading at a discount to the current market price. With these two factors working with each other, a low-risk, moderate-reward opens itself up for investors to potentially exploit and make some money.
McDonald's has a healthy dividend that can offer investors higher returns if they choose to reinvest it. Given that McDonald's shares are also trading at a discount under the Gordon Growth Model, investors can also benefit from share price appreciation. These two factors, with the addition of McDonald's low risk business operations, gives investors a low risk opportunity to make decent returns.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Although I currently am employed at a McDonald's store, I am not writing this article on the behalf of the company. My reasons for writing this article are simply to express some of my opinions about the company and I am not receiving any sort of compensation (other than from Seeking Alpha) to write this article.