- Both McDonald’s and Chevron “currently” yield about 3.4%.
- However, it would be inaccurate to assume that the income produced by each is equivalent.
- This article looks into the idea that all dividend yields are not created equal.
In 1940 Dick and Mac McDonald had an idea for a restaurant: McDonald's Bar-B-Q. It survived for a while as your typical drive-in of the era featuring a large menu and carhop service. By 1948 the concept had gotten a bit stale, so the brothers closed up shop and reestablished the company as "McDonald's (NYSE:MCD)." They simplified the name and streamlined the business -- creating a self-service drive-in restaurant with just 9 menu items. They had a winner. By 1954 the brothers were looking to franchise and along came Ray Kroc. The rest, as they say, is history.
Tracing its roots back 60 years prior to McDonald's, modern-day Chevron (NYSE:CVX) began as the Pacific Coast Oil Company in 1879. After a few decades, consolidation became the name of the game, creating the Standard Oil Company of California. Eventually the company took the name "Chevron" in the 1980s. Today the company employs about 65,000 people and produces over 2 and a half million barrels of oil per day.
Although the histories of an oil firm and a restaurant company diverge greatly, they do share quite a few commonalities. For instance, both were established in California, and it could be argued that the main product is fuel: fuel for your car and fuel for your body. More recently, the business and performance results of the two businesses have proved quite similar. Both McDonald's and Chevron have been able to grow operating earnings per share by about 9% annually since 2000 -- resulting in total investment gains in the 9%-10% yearly range.
On the dividend front, both companies have been extraordinarily impressive. Chevron has not only paid but also increased its dividend for 27 consecutive years. Over the last 10 years, these increases have come at an annual rate of about 10%. McDonald's record has proven to be even more remarkable, having increased its payout for 38 straight years at a rate north of 20% for the last decade. Additionally, both companies presently have a "current" yield of about 3.4%.
Thus, on the surface it might appear as though an investment in either company today would produce the same income results. Yet the problem with this type of thinking is that "current" yields rarely reveal a great deal of pertinent information. The quoted yields you see on any financial website are based upon the most recent quarterly payout -- that number is then annualized and assumed to be meaningful. However, this misses several key analysis factors and doesn't tell you much about the prospects moving forward.
I'll give you some questions to demonstrate what I mean. If McDonald's and Chevron both have "current" yields of 3.4%, which company would you expect to generate more income in the next year? How about the next 5 years? If you expect the companies to be structured similarly in the future, will the income streams be equal? What if they're structured differently?
Let's take a look at these questions individually to develop some insight. Which company would you expect to generate more income in the next year?
From the onset, you might believe that equal investments in McDonald's and Chevron would give you equal amounts of income in the next year -- after all they have the same "yield." Yet this is missing the point of timing. In April of this year, Chevron announced a dividend increase, meaning that the investor of today would most likely receive three $1.07 payments per share, plus a higher fourth payout (if CVX raises its dividend for the 28th straight year) over the next 12 months. The three $1.07 payments are related to the "current" yield of 3.4%.
On the other hand, McDonald's often announces a dividend increase in September and pays a higher dividend each December. Stated differently, McDonald's has not yet announced its dividend increase for this year, and thus the most likely scenario for today's investor is that they receive one $0.81 dividend per share followed by 3 higher payments. In this case, just one payment is related to the "current" yield of 3.4%.
So the answer to the question is that McDonald's should be expected to provide more income over the next year -- purely as a consequence of the company being closer to its dividend increase.
How about the next 5 years?
Again the answer is McDonald's -- although this one is less certain. If you expect Chevron and McDonald's to increase the dividend payments by the same rate, MCD continues to win out due to the closer increase mark. However, if you expect Chevron to increase its dividend at a quicker rate, the math could shift to CVX's favor.
If you expect the companies to be structured similarly in the future, will the income streams be the same?
The answer to this is "no," and in turn it likely could mean an income "win" for Chevron. McDonald's presently pays out about 59% of its earnings. Alternatively, Chevron presently pays out about 42% of its profits. Thus if you assumed the long-term business results to be similar -- and the companies to pay out 50% of profits, for instance -- you would see Chevron's dividend growth outpace McDonald's.
What if the companies are structured differently?
Again, the income streams likely wouldn't be equal. The payout ratios could remain the same for each company, but the business results will probably vary. Alternatively, even the exact same business results do not necessitate stagnant payout ratios.
Here's the bottom line: if you take a quick look at both McDonald's and Chevron, you would notice a "current" yield of about 3.4%. As such, you might instantly imagine the income streams to be equal. Yet this ignores the bulk of the analysis. The answer depends upon the timeframe involved. If you're talking about a year, the answer is almost certainly McDonald's. If you're referring to a couple of decades, the investigation requires a bit more thought. It's all about expectations -- how fast will the companies grow, what might be an appropriate future payout ratio and what does this mean for the dividend growth rate? In the end, I have no idea which company will provide more dividend income. (Incidentally, both appear to be reasonable places to begin one's research.) However, I do know that equal "current" yields are not likely to be indicative of future income equivalence.