McDonald's And The Benefit Of A Declining Stock Price

| About: McDonald's Corporation (MCD)

Summary

McDonald’s has provided very solid investment results in the past decade or so.

From 2011 through today, the share price went from about $100 to $115.

This article looks at the in-between stages and discusses which path you might have preferred.

When you flip on a finance show or scan through daily investing headlines, the resulting sentiment is always the same. They will tell you about what the "market" did on that particular day -- up or down -- and then the rest of the emotion or attitude follows suit. Dow down 2%? You can physically see the pain on Jim Cramer's face as he offers consolation. S&P 500 up 3%? Look out record highs! And even if you didn't hear a word, the red or green colors and up or down arrows will quickly tell you how one ought to feel. We're programmed to think "up = good, "down = bad."

It seems logical enough. You invest to make money, not lose money. Yet I would contend that this everyday pricing and reacting mentality is a lot more hurtful than it is helpful. And as you're about to see, it may not even be as logical as you originally suspect.

To create this illustration I'll use McDonald's (NYSE:MCD) as an ongoing example. During the past decade McDonald's has been an exceptional investment. It hasn't come in even flows, but over time the business and investment have done quite well.

Now imagine you decided to invest in McDonald's at the end of 2011. At that time the share price had closed at $100.33. As I write this, the company's share price is around $115.60 or thereabouts. In addition you would have received dividend payments along the way. Here are the dividend payments that you would have collected:

2012 = $2.87

2013 = $3.12

2014 = $3.28

2015 = $3.44

This occurs no matter what the share price happens to be. In total you would have received $12.71 per share in dividend payments. This brings the total value (prior to reinvestment) up to $128.31, for an annualized return of about 6.3% per year. Now in between this time, the share price jumped around quite a bit. I'm going to show you two sets of share price numbers -- what actually occurred and a hypothetical situation -- to continue with the demonstration. We'll call them "Option A" and "Option B." Here's "Option A:"

Year

Price

2011

$100.33

2012

$103.95

2013

$107.69

2014

$111.58

2015

$115.60

Today

$115.60

Click to enlarge

Here's "Option B:"

Year

Price

2011

$100.33

2012

$88.21

2013

$97.03

2014

$93.70

2015

$118.14

Today

$115.60

Click to enlarge

Now which option would you have preferred? Be honest. The first option shows a nice constant growth scenario where the share price goes up year after year. The second scenario shows a true roller coaster ride. In three different instances (including the end of 2015), you would have seen lower share prices to come. If the media and general human psychology are any guide, I would guess that at least some of you would prefer Option A to Option B.

You end up in the same place with both price-wise, but Option A is a lot smoother of a ride. Unfortunately (or fortunately depending on you viewpoint) Option A is a fantasy. It's made up. Option B is what actually occurred during this timeframe. Luckily this is actually quite good news. A lot of people bemoan lower share prices, but for the long-term owner -- as long as the business remains fundamental -- it's good news. I'll show you.

The reason that lower share prices in the short and intermediate term are good for long-term owners is that long-term owners are apt to be long-term net buyers as well. This is accomplished either via "fresh" or new capital, reinvestment or on your behalf via share repurchases.

Let's think about reinvestment first. Had you invested $10,000 into McDonald's at the end of 2011, you could have purchased approximately 99.7 shares. Those shares would go on to pay $286 in dividends during 2012, which could then be used to reinvest back into the company to add more shares.

If done at a price near $104, you could add about 2.75 new shares. If done at a price closer to $88 (as was actually the case), you could have added 3.25 new shares. The benefit is easy to see -- a lower share price allows your dividends to buy more shares and in turn these new shares pay out more dividends.

Today you could be sitting on 113 shares if you reinvested at the actual prices or just 111.7 shares had the constant growth "Option A" scenario actually occurred. A lot of people root for higher prices as they reinvest. With a long-term mindset, it's the opposite situation that will ultimately provide more income and wealth.

Naturally this works with investing new capital as well. Had you invested $10,000 at the end of every year in the first scenario, and continued to reinvest, the total value of your holdings would now be about $57,000. Alternatively, had you invested $10,000 per year at the actual prices, and continued to reinvest, those shares would be worth just under $63,000.

Logically this all makes a good deal of sense. Despite buying at the end of 2015 at a higher price, you would have been buying shares at lower prices in the other years. Buying at a lower price allows you to purchase more shares. Not only do more shares provide more income, but you also get a better "snap back" effect when the share price does eventually rise.

And obviously, the same sort of math takes place when a company is repurchasing shares as well. As a remaining shareholder, you want the company to buy out past partners as cheaply as possible. It's buying at higher prices that helps those past partners and hurts the remaining stakeholders.

In short, recognizing cases of curious investor psychology can help you get a better handle on your protecting your investing goals. You see it all the time. Long-term investors -- who will be adding new capital month-after-month, year-after-year, decade-after-decade -- cheer for higher and higher prices. Lower prices then, as the off-putting reasoning goes, are to be feared. Yet this line of thinking doesn't pass the logic test. As a group we make no such error in purchasing and cheering for gasoline or milk prices. Yet something about the investment world adds this "doom and gloom" factor to the mix. As we've just seen, lower prices -- especially in the face of an ultimately sustainable business or group of businesses -- ought to be cheered.

Disclosure: I am/we are long MCD.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.