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Is It Time to Buy the Golden Arches?

The world knows and loves McDonald's (NYSE: MCD), a point driven home by the following mind-blowing fact: Global recognition of McDonald's iconic Golden Arches was 88% while the Christian cross, the symbol of the world biggest religion, boasted a 54% global recognition rate.

McDonald's unparalleled brand awareness, and what that does for profitability, surely figured in the company's announcement last month of a 7% increase in its dividend. This marked the 45th consecutive annual dividend increase, placing McDonald's firmly among the Dividend Aristocrats, which is made up of the S&P 500 companies that have raised their payouts for at least 25 years straight.

This raises the question: Should dividend growth investors show McDonald's some love and buy its stock at current prices?

A smiling person at a drive-thru restaurant holding a bag and a cup holder with two drinks.

Image source: Getty Images.

Strong operating results

Through the first half of this year, McDonald's has served up robust results to its shareholders.

For starters, McDonald's revenue in the first half of 2021 surged 29.9% year from a year earlier to $11.01 billion. And while this revenue figure was skewed because of the hit to business in last year's first half amid COVID-19 disruptions, McDonald's revenue also grew at a healthy clip compared to 2019, rising 6.9% from pre-COVID revenue of $10.30 billion. This suggests that the fundaments for McDonald's, with almost 40,000 franchised and company operated restaurants, are stronger than ever.

A key factor that has allowed McDonald's to come out of the pandemic stronger than it was heading into it is the company's emphasis on digitally connecting with customers. The McDonald's app is the most downloaded quick-service restaurant app in the U.S., company Chief Executive Officer Chris Kempczinski said during the second-quarter 2021 earnings call. McDonald's digital sales grew 70% in the second quarter from a year earlier to $8 billion, which is an indication of the company's digital sales growth potential.

McDonald's non-GAAP earnings per share (EPS) more than doubled year over year to $4.29 in the first half of 2021. But again, this isn't very surprising considering the pandemic restrictions McDonald's faced last year. What's more impressive is that McDonald's managed to increase its non-GAAP EPS by 16.3% this year from the first half of 2019, when it earned $3.69 per share.

Based on this year's revenue and EPS gains, McDonald's has recovered from COVID-19 headwinds and growth has rebounded to pre-pandemic rates. This bodes well for shareholders.

A solid balance sheet

While it's encouraging that McDonald's is turning out strong operating results, it's just as important that the underpinnings of the company's balance sheet are fundamentally sound.

Let's take a look at McDonald's earnings before interest and taxes (EBIT) and compare it to McDonald's interest expenses, which is another way of saying the interest coverage ratio.

As McDonald's has rebounded from COVID-19, its interest coverage ratio has soared from 4.5 through the first half of last year to 8.3 in the first half of this year.

Put another way, McDonald's EBIT would need to plunge almost 90%, or interest expenses would need to soar (or some combination of the two), before McDonald's would be unable to service its debt.

Yet even amid the COVID lockdowns, McDonald's EBIT fell only 38.8% in the first half of 2020 from the first half of 2019. A decline of 90% in EBIT seems quite unlikely.

And since 95% of McDonald's debt at the end of last year was fixed-rate, McDonald's is largely shielded from rising interest rates bumping up its interest expenses.

Therefore, solvency issues should be far from mind.

A reasonably priced Dividend Aristocrat

McDonald's is a dividend stock that investors shouldn't overlook.

The stock's track record of almost a half-century of dividend increases appears to be just the beginning.

Apart from the strength of McDonald's earnings and balance sheet, the company dividend payout ratio is poised to be in the high-50% range this year. This leaves McDonald's with a buffer that should allow it to raise the dividend more or less in line with projected annual earnings growth in the high single-digit percentages during the next few years.

At about $249 a share, McDonald's isn't cheap, nor is it overvalued. Based on the analyst consensus estimate of $9.47 in non-GAAP EPS, McDonald's is trading at a forward price-to-earnings (P/E) ratio of 25.3. This is only moderately higher than the S&P 500's forward P/E ratio of 21.3, which doesn't seem out of line for a company of this quality.

That's why I would advise dividend growth investors to consider McDonald's 2.3% dividend yield, if they haven't already, and to buy on any weakness in the future.

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

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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