Investors looking for high-quality dividend growth stocks should consider the Dividend Aristocrats. When it comes to dividend growth stocks, the Dividend Aristocrats are hard to beat. They are a group of stocks in the S&P 500 Index with 25+ consecutive years of dividend increases. You can see all 51 Dividend Aristocrats here.
McDonald’s (MCD) and Coca-Cola (KO) are both Dividend Aristocrats, and the two companies are closely tied. Those who enjoy a trip to McDonald’s, often wash it down with a Coca-Cola. McDonald’s and Coca-Cola are both highly profitable companies, with strong brands, and should continue to increase their dividends each year.
But the past year has treated McDonald’s and Coca-Cola much differently.
Coca-Cola has had a good year, with a 15% total return (including share price appreciation and dividends). But Coca-Cola is no match for McDonald’s, which has produced a 46% return year-to-date. McDonald’s has delivered more than three times Coca-Cola’s returns in 2017.
McDonald’s has been the far more rewarding stock to own, and its investors have done much better than Coca-Cola’s. But due to its huge rally, McDonald’s now appears to be overvalued, while Coca-Cola still has a reasonable valuation. This article will discuss why value and income investors might favor Coca-Cola for 2018.
Coca-Cola and McDonald’s both have tremendous brands, and lead their respective industries. For example, Coca-Cola is the 5th most valuable brand in the world, while McDonald’s has the 9th most valuable brand. But right now, McDonald’s fundamentals are in better condition.
Coca-Cola is the world’s largest beverage company. It owns or licenses more than 500 non-alcoholic beverages, including both sparkling and still beverages. It sells its products in more than 200 countries around the world, and has 21 brands that generate $1 billion or more in annual sales.
The core sparkling beverage portfolio includes the flagship Coca-Cola brand, as well as other soda brands like Diet Coke, Sprite, Fanta, and more. Coca-Cola also has a large portfolio of still beverages, including Dasani, Minute Maid, Vitamin Water, and Honest Tea. Coca-Cola enjoys top market share positions across a number of its core product categories.
Source: 2017 Investor Day Presentation, page 4
Coca-Cola’s growth has not been as impressive as McDonald’s in recent periods. For example, in 2016, Coca-Cola’s organic revenue increased 3%, while adjusted earnings-per-share rose 5%. Earnings growth was due to price increases, volume growth, and share repurchases. Organic revenue increased another 2% over the first three quarters of 2017, driven by price increases.
Meanwhile, McDonald’s is the largest publicly-traded fast food company in the world. It operates over 37,000 locations, in more than 100 countries around the world.
2016 was a year of recovery for McDonald’s. Global comparable-restaurant sales increased 3.8% for the year. Adjusted earnings-per-share increased 16% last year. McDonald’s has enjoyed a successful turnaround, driven by increased franchising and new menu initiatives such as all-day breakfast.
2017 has been another good year for McDonald’s. Revenue declined 6% over the first three quarters, but this was driven mostly by the sale of its businesses in China and Hong Kong, and increased franchising. However, these initiatives have improved McDonald’s profitability. Adjusted earnings-per-share increased 16% through the first three quarters.
While McDonald’s has reported stronger growth over the past year, the bad news is that investors now have to pay a hefty price for this growth. In the past four reported quarters, McDonald’s had adjusted earnings-per-share of $6.40. Based on this, the stock has a trailing price-to-earnings ratio of approximately 26.9.
McDonald’s is valued significantly above the S&P 500 Index, which has an average price-to-earnings ratio of 25.8. Therefore, McDonald’s appears to be slightly overvalued, while Coca-Cola is still valued below the S&P 500.
Coca-Cola had adjusted earnings-per-share of $1.89 per share in the past four quarters. As a result, the stock trades for a price-to-earnings ratio of 24.3. McDonald’s is valued approximately 11% above Coca-Cola.
McDonald’s valuation premium could be justified, if it continued to generate significantly higher earnings growth than Coca-Cola. But analysts expect McDonald’s momentum to slow in the years ahead, while Coca-Cola is still in the early stages of its turnaround.
According to ValueLine, McDonald’s is expected to increase earnings-per-share by 7% in 2018, and by approximately 9% per year from 2020-2022. For its part, analysts expect Coca-Cola to grow earnings by 3% in 2018, but growth is expected to accelerate to 11% per year from 2020-2022.
When it comes to dividends, Coca-Cola has the advantage. There is no doubt that McDonald’s has an impressive dividend history—it has increased its dividend every year since its first payout in 1976. The most recent hike was a 7% raise on September 21st.
In the past five years, McDonald’s has a compound annual dividend growth rate of approximately 5.5%. Coca-Cola has increased its dividend by 7.7% per year, over the past five years, which is a higher dividend growth rate than McDonald’s in the same time frame.
The other disadvantage of McDonald’s dividend, is that it has a fairly low yield. Due to the huge share price rally in the past year, the stock has a dividend yield of 2.3%.
On the other hand, Coca-Cola’s share price has not appreciated nearly as much as McDonald’s, which has kept its dividend yield elevated. Coca-Cola has a dividend yield of 3.2%.
This means Coca-Cola offers 39% more dividend income than McDonald’s, which is a significant difference.
Coca-Cola also has a longer history of dividend increases than McDonald’s. Coca-Cola has increased its dividend for 55 years in a row. In addition to being a Dividend Aristocrat, Coca-Cola is also a Dividend King, an even smaller group of just 22 stocks. You can see all 22 Dividend Kings here.
McDonald’s and Coca-Cola are both world-class brands. Each stock is likely to generate positive returns for shareholders moving forward, through earnings growth and dividends. But investors should try to avoid buying stocks when they are overvalued. Future returns can be mediocre or poor, even from strong businesses, if too high a price is paid for earnings growth.
McDonald’s has enjoyed a massive rally this year, which has elevated its valuation, while Coca-Cola has not rallied nearly as much. Coca-Cola remains fairly valued, and has a higher dividend yield than McDonald’s. As a result, value and income investors might prefer Coca-Cola to McDonald’s right now.
McDonald’s and Coca-Cola are both high-quality Dividend Aristocrats. But there are other Dividend Aristocrats that are even more undervalued than McDonald’s and Coca-Cola. Our service Undervalued Aristocrats provides actionable buy and sell recommendations on some of the most undervalued dividend growth stocks around. Click here to learn more.
Disclosure: I am/we are long MCD.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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