- In the last 10 years, McDonald's has cut the total shares outstanding by over 30%. What has happened as a result?
- Sales have been flat to lower over the period. Net income rose by one-third, but earnings per share are up over 91%. Solely due to buybacks.
- Likewise, the cost to McDonald's for the dividends it has paid in million has grown 56.4% over the past 10 years. But dividends per share have risen 125% in the same period.
- One thing we can do is ask what if McDonald's had not bought back any shares? What if all they did is pay out 100% of the amount if bought back in dividends? What would be the return to investors?
- The results are astounding. After this, you will better understand why companies like MCD pursue buybacks, even though the stock price rises while they are buying shares back.
- This idea was discussed in more depth with members of my private investing community, Total Yield Value Guide. Get started today »
McDonald's Corp. Is A Good Example Of The Success Of Buybacks
It turns out that McDonald's Corp. (NYSE:NYSE:MCD) is a great example to show why buybacks successfully return capital to shareholders. The reason is that MCD stock has done quite well over the past 10 years while the company has been repurchasing shares.
Keep in mind that sales have basically been flat for this period. You can see this in the chart below:
Source: Mark R. Hake, CFA
In fact, over the period from 2009 to 2019, MCD's sales have actually fallen 7.3% over that period.
Moreover, the company has decided to increase the portion of sales from franchisees rather than corporate-owned stores. In the past few years, more sales have come from franchisee stores than parent stores:
Source: Mark R. Hake, CFA
Part of the reason for this was to increase free cash flow ("FCF") since there would be less capex spent on corporate stores. The net result has been that FCF has grown in the last several years. In addition, FCF margins have increased greatly over the last 10 years. You can see this in the chart below:
The blue line shows that FCF has increased to 27% in 2019 from just 17% in 2009.
FCF Growth Spurred Buybacks And Share Count Reduction
What did MCD do with that extra FCF? It spent large amounts on buybacks. You can see in the chart below that MCD decided to spend more and more on buybacks than dividends over the past 10 years:
The idea, from MCD's standpoint, was to reduce the share count through the buybacks. And that is exactly what happened. Over the past 10 years, MCD cut its shares outstanding by almost one-third:
Source: Hake, using Seeking Alpha data
So, clearly, MCD got what it wanted. Higher FCF, which led to higher buybacks, which led to higher buybacks plus dividends.
In fact, we can clearly make the case here that the dividends per share increased much faster because of the buybacks. You can see this in the two tables below:
Source: Hake calculations
This shows that the dividends per share (table on right) have increased by 125% over the past 10 years. But the cost of dividends rose by only 56.4%.
So, in effect, shareholders got a doubling of the dividend per share through the buybacks. A similar effect occurred with the earnings per share.
What If McDonald's Had Only Paid Out Dividends With The FCF?
I write exclusively about companies with total yield, i.e., companies that buy back their stock and pay dividends. Often, I hear a complaint that you cannot spend buyback yield. But this is a fallacy. I wrote a recent article in Seeking Alpha to describe the math behind the rationale for buybacks.
I want to take this a step further with this article on McDonald's. What would the situation look like if MCD had spent in dividends for shareholders the money it otherwise spent on buybacks? Would shareholders now be better off?
It turns out that is not very hard to figure out. We can accumulate the dividends per share, calculate the gain in the stock price and compare that with the present situation - all using the past 10 years of data.
Scenario A. In this scenario, there are no buybacks starting from the end of 2009. The number of shares stays the same. But there are higher amounts of dividends paid out:
In this case, you can see that $75.53 in total dividends would be paid out to shareholders. But the share count would stay the same as in 2009.
The Price Gain was calculated as follows:
Today's P/E ratio of 23.3 is used as a multiple for the Net Income in 2019. This results in market value of $140.4 billion today. This is close to today's $148.4 billion market value. However, since there are significantly more shares outstanding (as there would be no buybacks), the stock price would be $130.35 per share. Today, after the recent drop in price, the stock is $198.86.
The price at the end of 2009 was $62.44. Therefore, the price gain was $66.91. And the total return to shareholders was $142.43 over 10 years. That means the ROI, starting from $62.44 was 128.1% or a CAGR of 12.6%.
However, since so many dividends were paid out, we also have to figure the after-tax return to the shareholder. Assuming a 25% rate (you can use whatever rate you want), the net after-tax dollar gain will be $123.55, an ROI of 97.9% over 10 years, and a CAGR of just 11.5%.
Scenario B: The Present Situation. Compare Scenario A to what actually happened:
In the last 10 years, there were $35.91 per share in dividends paid out. This is significantly lower than the Scenario A case where $75.53 would be paid out. Remember Scenario A uses the money that would otherwise be used for buybacks as dividend payments. In Scenario B (reality), the buybacks reduced the share count. But there was still money paid out in dividends on these lower shares.
The net price gain is much higher. The stock closed at $197.61 at the end of 2019 and is $198.86 today (March 8). So the net gain was $136.42 per share, vs. only $66.91 in Scenario A.
Now, you can see from the table above, even after the net tax effect on the dividends that the total return to shareholders is 161.6% over 10 years. This works out to a 13.7% CAGR.
That is a significantly higher return than in Scenario A. You can see this in the chart below:
The point here is that the ROI is much higher over the 10 years with the buybacks. Shareholders would have made much more money on an after-tax basis with the buybacks than if the money spent on buybacks was spent on dividends instead. There is simply no question about this.
How do you spend the money you would otherwise have gotten in dividends? You can sell a portion of your shares each year. You will still come out ahead, since the remaining shares will have higher dividends associated with them than otherwise the case.
What Is McDonald's Stock Worth?
Here is the thing. We can estimate MCD stock is worth using our estimate of FCF for the coming year and dividing it by the FCF yield today. That will give us the market value in millions of dollars. Then, since we estimate that the buybacks result in about a 2.5% per year reduction in share count, we can estimate the price per share. Here is how that works out:
Source: Hake estimates
This shows that our estimate is $230.26 per share for MCD stock. That represents a potential gain of almost 16% from the present stock price.
Summary And Conclusion
McDonald's has had a robust buyback program over the past 10 years. We calculate that if the company had not done this, shareholders would have lost significant value. MCD stock is worth $230.26 per share, or an upside of 16% from today.
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