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Is This Dow Jones Stock a Buy for Income Investors?

The Motley Fool logo The Motley Fool 2/15/2023 Kody Kester

The Dow Jones Industrial Average consists of 30 of the best and biggest companies on the planet. Unsurprisingly, 28 of these well-established businesses pay dividends to shareholders, giving them a steady stream of passive income. This means that the index is loaded with numerous smart options for dividend growth investors.

Fast food giant McDonald's (NYSE: MCD) is a popular stock for investors seeking rising passive income to own. But is it currently a buy for income-oriented investors? Let's dig further into McDonald's fundamentals and valuation to find out.

Another quarter of growth for the golden arches

With more than 40,000 (mostly franchised) restaurants around the world, McDonald's is the unquestionable leader of the fast food industry. The company's iconic brand and the affordability of its dollar menu have made it a favorite among consumers for countless decades.

This argument was once again underlined in the company's latest quarter. McDonald's revenue declined 1.4% year over year to $5.9 billion for the fourth quarter ended Dec. 31. While this initially may seem unfavorable to shareholders, there is more to the story.

Given McDonald's significant international operations, it shouldn't be shocking to learn that the company faced a significant hit to sales as fallout from the abnormally strong U.S. dollar. This factor was a 6% headwind to McDonald's revenue during the quarter.

The company also had an unfavorable year-ago comparison because its results included revenue earned from operations in Russia and Ukraine. Because of the war between the two countries, McDonald's completely withdrew from the former, and has faced disruptions to its business at many locations in the latter. This pressured revenue in the fourth quarter.

But there was a major bright spot that led to 12.6% global comparable sales growth during the fourth quarter. McDonald's efforts to grow its customer loyalty program has paid off. At the end of 2022, the company had nearly 50 million active loyalty users in its top six markets. Since these customers are more likely to spend more frequently and heavily than non-loyalty-program customers, this was the driving force in McDonald's admirable global comparable sales growth.

The fast food chain's non-GAAP (adjusted) diluted earnings per share (EPS) surged 16.1% higher over the year-ago period to $2.59 for the fourth quarter. Careful cost management allowed McDonald's non-GAAP net margin to improve by almost 420 basis points year over year to 32.1% during the quarter. Combined with a 2.1% reduction in the company's outstanding share count, this explains how adjusted diluted EPS grew at a much faster clip than revenue in the quarter.

Continued growth in the company's customer loyalty program should fuel future earnings growth. That's why analysts are projecting that McDonald's will generate 7.3% annual adjusted diluted EPS growth through the next five years.

Customers wait in line at a fast food restaurant. © Getty Images Customers wait in line at a fast food restaurant.

Future dividend growth could remain strong

The 2.3% dividend yield on McDonald's shares is especially attractive compared to the S&P 500 index's 1.6% yield. And the company's above-average starting income also comes with a side order of dividend growth.

This is because McDonald's dividend payout ratio was just 56% in 2022. That should allow the company to hold onto enough of its profits to further strengthen its loyalty program and balance sheet moving forward. This is why I expect McDonald's to hand out many more dividend increases in the next few years, following the most recent 10.1% dividend hike.

A discounted valuation makes the stock a buy

McDonald's is a fundamentally solid company. And the valuation of the stock appears to present a buying opportunity for dividend growth investors.

McDonald's forward price-to-earnings (P/E) ratio of 22.5 is marginally below the restaurants industry average of 24. This isn't an Earth-shattering bargain, but any discount for a business with just shy of a half-century of dividend growth makes the stock arguably worth buying.


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Kody Kester has positions in McDonald's. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.


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