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Summary

  • Find out which of these two convenient food and beverage retailers makes the best investment for dividend growth.
  • Starbucks has grown revenue per share faster than McDonald's over the last 10 years.
  • McDonald's has a significantly higher yield.
  • Both businesses are doing well internationally.
  • Both Starbucks and McDonald's have industry leading brands.

McDonald's (NYSE:MCD) is the largest fast food chain in the world by market capitalization. The company's market cap is nearly $100 billion. Starbucks (NASDAQ:SBUX) is the world's largest publicly traded retail coffee company, with a market capitalization of around $60 billion. Both businesses compete in the crowded fast service industry, with McDonald's offering coffee to go with its established foods, and Starbucks offering food to go with its established coffee business.

McDonald's and Starbucks are both fast service food and beverage establishments. McDonald's is focused on fast food quickly, while Starbucks is focused on quality. Both businesses have established strong brands for themselves in the food and beverage industry. This article examines Starbucks and McDonald's using the 5 Buy Rules from the 8 Rules of Dividend Investing. The 8 Rules of Dividend Investing identifies high quality businesses trading at fair prices or better prices. This article is not a comparison of McDonald's coffee to Starbucks coffee. Coffee is a small part of McDonald's business, while Coffee is the core of Starbuck's business. This article compares the whole company McDonald's to the whole company Starbucks.

The 8 Rules of Dividend Investing works by comparing businesses a long history of dividend payments to each other. This type of comparison creates a quantitative way to determine and rank high quality dividend stocks.

Consecutive Years of Dividend Payments

Starbucks does not have a long history of increasing dividends. The business began paying dividends in 2010, and has increased dividends annually since that time. Starbucks will be compared to other businesses that do have a long history of dividend increases in this article. Starbucks is a dividend growth stock as evidenced by its 4 years of increasing dividends. Further, the company shows strong evidence of a durable competitive advantage due to its strong brand, rapid profitable growth, and dominant position among retail coffee shops.

McDonald's has increased its dividend payments for 37 consecutive years. The company's ability to grow profitably for over 3 decades shows the strength and durability of McDonald's competitive advantage.

Why it matters: The Dividend Aristocrats (stocks with 25-plus years of rising dividends) have outperformed the S&P 500 over the last 10 years by 2.88 percentage points per year.
Source: S&P 500 Dividend Aristocrats Factsheet, February 28 2014, page 2

Dividend Yield

· McDonald's has a dividend yield of 3.23%, the 29th highest out of 128

· Starbucks has a dividend yield of 1.32%, the 111th highest out of 128

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Why it Matters: Stocks with higher dividend yields have historically outperformed stocks with lower dividend yields. The highest-yielding quintile of stocks outperformed the lowest-yielding quintile by 1.76 percentage points per year from 1928 to 2013.
Source: Dividends: A Review of Historical Returns

Payout Ratio

· McDonald's has a payout ratio of 58.84%, the 85th lowest out of 128

· Starbucks has a payout ratio of 38.81%, the 40th lowest out of 128

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Why it Matters: High-yield, low-payout ratio stocks outperformed high-yield, high-payout ratio stocks by 8.2 percentage points per year from 1990 to 2006.
Source: High Yield, Low Payout by Barefoot, Patel, & Yao, page 3

Long-Term Growth Rate

The long-term growth rate of each business is calculated as the lesser of the 10-year per share growth in either dividends or revenue.

· McDonald's has a growth rate of 7.09%, the 30th highest out of 128

· Starbucks has a growth rate of 8.83%, the 12th highest out of 128

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Why it Matters: Growing dividend stocks have outperformed stocks with unchanging dividends by 2.4 percentage points per year from 1972 to 2013.
Source: Rising Dividends Fund, Oppenheimer, page 4

Long-Term Volatility

Long-term volatility for each business is calculated as the 10-year price standard deviation.

· McDonald's has a standard deviation of 20.14%, the 17th lowest out of 128

· Starbucks has a standard deviation of 33.73%, the 88th lowest out of 128

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Why it Matters: The S&P Low Volatility index outperformed the S&P 500 by 2 percentage points per year for the 20-year period ending September 30th, 2011.
Source: Low & Slow Could Win the Race, page 3

McDonald's Current Events & Growth Prospects

McDonald's revenue comes from both company owned stores (67%) and franchised stores (23%). This is misleading however, as the franchised stores have significantly higher margins than the company owned stores. The franchise unit contributed 70% of gross profits versus just 30% for the store owned businesses.

McDonald's operates 6,719 restaurants and licenses 28,774 additional restaurants over 120 countries throughout the world. The company is geographically diversified, with revenue spread relatively evenly through the US, Europe, and emerging markets.

Region

Revenue

% Total

US

$2,054.10

30.66%

Europe

$2,712.20

40.48%

Asia Pacific/Middle East/Africa (APMEA)

$1,618.80

24.16%

Other

$315.20

4.70%

Source: 2014 First Quarter Report

McDonald's has historically grown through increasing the number of its franchises. In addition, the company can generate growth through increasing same store sales with innovations like better layouts, better menus, and healthier food options.

McDonald's grew constant currency revenues 3% for the first quarter 2014. McDonald's expects to add between 1,000 and 1,100 restaurants in 2014, which represents a store count increase of between 2.8% and 3.1%. The company plans to modernize about 1,000 stores in 2014 as well.

Shareholders of McDonald's can expect long-term growth of around 3% due to McDonald's increasing store count, if same store growth stays flat. The company has historically been able to increase same store sales through innovative new product offerings. Notable company innovations include breakfast, coffee, and healthier menu items.

McDonald's growth opportunity lies with the APMEA division. Emerging markets are quickly growing middle class consumers. McDonald's ability to appeal to emerging market consumers will drive future growth. Currently, the company is generating about 24% of its sales from the APMEA division. Comparable store sales in APMEA increased 2.9% compared to last year in April. Total constant-currency adjusted APMEA sales increased 7.5% for the same period.

Starbucks Current Events & Growth Prospects

Starbucks was founded in 1971 and has grown to over 20,000 locations worldwide. The company posted favorable second quarter results, with net revenue increasing 9% globally. Sales growth was driven by 6% global comparable store sales growth, with the remaining 3% of growth coming from new stores. The company's China/Asia Pacific division had the most robust growth, posting 24% revenue growth for the 2nd quarter of 2014 versus the 2nd quarter of 2013.

Source: Starbucks 2nd Quarter 2014 Earnings Release

Starbucks has an opportunity to achieve significant revenue growth by increasing the percentage of customers who bundle food with a drink. Currently, about 1/3 of Starbuck's customer buy a food item along with a drink. The company is rolling La Boulange Bakery products to all US stores by the year end of 2014. La Boulange Bakery is San Francisco based bakery that has been serving artisanal pastries and food since 1996. The move should help bolster Starbuck's food sales.

Source: Starbucks William Blair Growth Stock Conference Presentation

In addition to breakfast and snack food items, Starbucks is also attempting to expand into evening wine, beer, and small food plates. The company plans to open 1,000 evening stores over the next several years. The possibility of Starbucks generating revenue from targeted breakfast, lunch, and dinner items could drive growth in the future.

Source: Starbucks William Blair Growth Stock Conference Presentation

Starbucks has performed well since 2009. The company's earnings per share dipped in 2008 and 2009 as consumers cut back on relatively expensive Starbuck's coffee. Since 2009, Starbucks has grown earnings per share at a rapid clip as both sales and operating margins have increased.

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Source: Starbucks William Blair Growth Stock Conference Presentation

Final Thoughts

Both Starbucks and McDonald's have long growth runways ahead. Starbucks and McDonald's are both doing will in emerging markets. Starbucks is growing quicker than McDonald's, but the difference is not as great as one would think on a revenue per share basis due to McDonald's strong share repurchases and growth of its own.

The 8 Rules of Dividend Investing ranks McDonald's as a Top 10 stock due to its strong growth rate, low volatility, and relatively high yield. Starbucks is not a Sure Dividend stock as it does not have 25+ years of dividend payments without a reduction. If it did, it would have only an average rank due to its high volatility and low yield, which is partially offset by strong growth.

Source: Is McDonald's Better Than Starbucks For Dividend Growth Investors?