With a dividend yield of just over 2%, McDonald’s (NYSE:MCD) doesn’t jump out as an obvious choice for passive income investors. But I think it’s worth a closer look.
In terms of returns, there’s more to the stock than just the dividend. And the company’s competitive position might well make it resilient going forward.
Business model
McDonald’s has built its reputation on quick service and bargain prices. And despite its recent results, I think offering better value than the competition has a durable appeal with customers.
Investors need to approach such businesses with caution though. Unless the company has a genuine advantage when it comes to costs, lower sales prices just mean lower profits.
Yet McDonald’s does have such an advantage. Instead of renting its venues, it buys them outright and leases them to the operators that run them.
This both reduces the company’s lease costs and gives it a source of income that isn’t about food sales. As a result, it can charge lower prices than competitors while maintaining strong margins.
Shareholder returns
Right now, McDonald’s shares come with a 2.3% dividend yield. That’s not much to get excited about, but there are a couple of things investors should take note of.
The first is the dividend is growing. The company has increased the amount it distributes to shareholders from $3.2bn to $4.7bn over the last 10 years.
The second is the firm has been buying back its own stock at an average rate of almost 3% per year. As a result, there are now fewer shares claiming a part of that growing dividend pot.
This means investors might expect McDonald’s to return around 5.3% of the current market cap in cash, with this increasing over time. That’s not at all bad from a business as good as this.
What’s the catch?
McDonald’s reported its first sales decline since the pandemic earlier this year. However, given the company’s cost advantage, I’m not actually all that worried about this.
Maybe that’s a mistake, but it’s not the biggest reason that stops me buying the stock at the moment. The main issue is tax.
Since McDonald’s is a US business, UK investors like me are eligible for a withholding tax on the dividends it pays. That’s a 30% tax, which comes down to 15% with a W-8BEN form.
That might not sound like much, but it brings the dividend yield below 2% and the overall return below 5%. And that’s enough to put me off buying the stock at the moment.
Valuation
I’d love to own shares in McDonald’s and it wouldn’t take much to bring the price to a level where I’d be comfortable buying. Right now though, I think the share price is just too high.
That makes the stock just too risky for me at the moment. But I’ll be watching the business carefully, especially when it reports earnings later this month.
