Large-cap dividend-yielding stocks are usually sought for their stability and reliability. Those with a global footprint, a history of increasing dividends, and strong free cash flow will outperform, and are considered “sleep well at night” stocks because they require little maintenance and stress. Sometimes these stocks will rise steadily in price, providing capital gains. Sometimes they’ll stay range-bound, in which case they become attracting for a covered-call strategy. In macro downturns, they fall less than the market, meaning their beta will be far below the market. All of this spells an attractive addition to a portfolio.
These have been the rationales behind buying and holding McDonalds (MCD), a dividend payer that is now yielding nearly 3.5% and with a long history of positive cash flow, a strong operating margin, and a history of returning cash to shareholders in just about any way possible, whether it’s dividends, buybacks, or investing in growth.
Yet fundamentals have led many to rethink the company, and bears on the name are easy to come by, especially in the popular press. To understand why, we only need to look at one chart:
This is the rate of comparable store sales growth globally, in the United States, and in the fastest growth region in the world: Asia. Each is trending downward since the beginning of 2014, and the trend is getting worse, not better. The decline in sales is worst in Asia, which is still growing at the fastest rate of the three regions, even with a slowdown in China. When the largest economy of the region grows at “only” 7% and your store sales are falling in that same region by over 7%, there is a problem.
This has led to caution, which has in turn hit the share price:
We’ve seen growth in the stock price since January 2014, but only recently and marginally—just a few months ago we were down over 7% on a name that has a beta of 0.35 and dividend increases going back for a long time, and a strong share buyback program in place. But the fear of comp store sales decline and a structural shift in eating habits around the world has made many question the long-term viability of the company.
The stock has since recovered because the company has promised a turnaround and has committed to large share buybacks. The company still has the cash flow to do both, and even if it fails to turn around, the sheer value of the company’s assets and existing business mean that a sudden plummeting share price and a death spiral of earnings are unlikely, even if we will see a slow and quiet decline in the company.
Right now, MCD’s P/E ratio is 22—higher than the market and much higher than most other large-cap stocks. The market is still pricing in a bit of risk in this name, and that risk should not be ignored. But sensationalist popular coverage of the company’s fall is overblown, and investors who react by shorting the stock are likely to suffer. Instead, a mixture of caution, developing a hedging strategy, or looking for high-growth alternatives as people change their dining habits, may be a more prudent way to respond.