"No man can become rich without himself enriching others"
Andrew Carnegie

Thursday, April 18, 2013

The Safety Net: The Golden Arches Continue to Glitter

English: The official logo.
English: The official logo. (Photo credit: Wikipedia)
By Wealthy Retirement

Boston, Apr.18, hot stock picks .- Every week in this column, I ask readers to submit the stocks they want me to examine from a dividend-safety perspective by leaving the ticker symbol in the comments section below. This week, because Joseph offered to buy me a drink the next time I'm in Rancho Santana, Nicaragua, I'm happy to take a look at his stock, McDonald's (NYSE: MCD).

Rancho Santana is a gorgeous spot on the Pacific coast, and since I plan on being there again sometime in the near future, Joseph, I'll take you up on your kind offer.

McDonald's is a $27.5 billion-a-year business, although I can report it got zero of my family's dollars this year.

Hard to believe, but my 9- and 11-year-olds have never eaten a meal from McDonald's (or any other fast-food joint). We're not health fanatics. The kids eat candy, ice cream, pizza and other junk instead of their vegetables, but we simply refuse to feed them fast food. They don't know what they're missing and don't seem to care.

But we are clearly in the minority.

Over 1 billion pounds of McDonald's beef is consumed every year in America. The company sells 75 burgers every second, and it feeds 1% of the world's population every day!

And all of those burgers, fries and Happy Meals produce a ton of cash - exactly what we like to see as dividend investors.

Grading the McDividend

McDonald's generated $7 billion in cash from operations last year. The figure was down 2.6% from the prior year, mainly due to higher income tax expenses.

Additionally, it spent $3 billion in capital expenditures, which includes the building of new stores, refurbishing old ones, expanding processing centers, etc.

That leaves McDonald's with $3.9 billion in free cash flow.

In 2012, the company paid $2.9 billion in dividends, for a payout ratio of 74%. That's right at the 75% threshold I use to gauge the safety of a dividend. Keep in mind, using free cash flow is the most conservative way of measuring cash flow and a company's ability to pay its dividend.

McDonald's has something else going for it, though. History.

McDonald's has raised its payout every year for 36 years. The last time the company did not raise its dividend, America was celebrating its bicentennial and a peanut farmer from Georgia was elected president of the United States.

That kind of dividend-raising track record sets the bar pretty darn high. Shareholders have come to expect a dividend increase every year. If the company decides not to raise the dividend and keeps it the same, the move would be viewed as if it were a dividend cut.

Investors would take it as a sign that something is wrong and they'd bail out of the stock.

Since the company pays out just 74% of its cash flow in the form of dividends, there is still plenty of room to raise the dividend even if the company has a bad year or two.

Although if that payout ratio gets above 75% and the company is unable to grow cash flow, I'd become cautious.

For now, there is no reason to believe that McDonald's will do anything different from what it has done for decades. It will sell billions of burgers every year, generate lots of cash and return more cash to shareholders than the previous year.

My family's cash just won't be part of the equation. ...
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