A Critically Important Factor When Assessing Dividend Stocks

Key Takeaways:

• There’s a reason why McDonald’s is such a great stock. 
• We do some basic math to show you why. 
• That said, not all dividend stocks are created equal. 

McDonald’s might be the ultimate dividend stock. 

Expand that chart out to five years and you’ll see the stock has returned a solid 88% or so. 

McDonald’s not only pays a dividend – $5.52 annually – it has raised that dividend for 46 years, making the company one of 66 dividend aristocrats. 

Why Does This Dividend Stuff Matter So Much?

Rough math here for illustration purposes. 

Let’s say you own 100 shares of MCD. 

The company pays out its $5.52 dividend quarterly. So each quarter, you receive a dividend of $1.38 per share. On 100 shares, you collect $138. You can keep that $138 as cash or, better yet, you can reinvest it to buy more MCD stock. 

Trading around $250 per share, you’ll add just 0.552 shares to your position. However, you’ll do this every single quarter. Over a year, that’s 2.2 additional shares of MCD stock. 

But let’s say McDonald’s continues to increase its dividend. 

We’ll assume the company increases it by 8%, which reflects reality over the last five years. Under this scenario, that $1.38 quarterly dividend becomes $1.49, or a $149 quarterly payout. At $250 a share, $149 gets you 0.6 shares of MCD.

You’re sharp so you see what’s happening here. 

With the combination of reinvestment and dividend increases, you increase your position size and income, allowing you to build (basically compound) your position in McDonald’s steadily over time. 

Don’t Get Fooled – And Screwed – By Dividend Yield 

When you pull up a quote for a dividend stock, you’ll usually see a stat called dividend yield. 

As of this writing, MCD yields 2.2%. 

This simply tells you the dividend income you’ll receive in relation to the price of a stock. 

In MCD’s case, you take the $5.52 annual dividend per share and divide it by its share price of $250 to come to that 2.2%. 

You’ll come across stocks with much higher dividend yields. 

Don’t fall for what dividend investors call yield traps. 

A high dividend yield can look attractive, but often only reflects the declining share price of a company. 

If MCD tanks to $100 tomorrow, its dividend yield will have increased to 5.5%. Unlikely yes, but, again for illustration purposes only. 

Such a drastic drop in share price could signal trouble at a company. Like maybe growth has stalled or something. It can also be temporary. 

This five-year chart on long controversial dividend stock AT&T (T) tells you all you need to know about the relationship between stock price and yield. 

Source: YCharts 

Generally speaking, as the stock price moved lower, AT&T’s dividend yield increased. The inverse holds true. 

For a good chunk of those five years, AT&T didn’t have its house in order. Sure, you collected what ardent T investors thought was a strong and stable dividend. However, you did so at the expense of growth and share price appreciation. 

Not the case with McDonald’s. 

The Bottom Line: In the present inflationary environment, you might be seeking investments that can generate meaningful income. 

Sensible. 

However, as the comparison between McDonald’s and AT&T illustrates, not all dividend stocks are great investments. Yield tells only a mere sliver of the story. It can distort your analysis if you don’t dig deeper. 

The best dividend stocks balance growth and income. 

Growth meaning growth prospects at the company and in its share price. Income meaning a formidable dividend from a company fully capable of paying the dividend and increasing it consistently over time.