Better High-Dividend Stock to Buy: McDonalds or Procter & Gamble?

By Markets Fool.com

Dow Jones giants McDonald's and Procter & Gamble both face major challenges. For Mickey D's it's the exodus from fast food that sparked the first drop in global same-store sales in over a decade. At the same time, P&G is seeing weak global demand for its products, made worse by historic currency swings that are destroying profits.

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But both companies remain cash-generating machines, with $14 billion of annual free cash flow between them.Each is also determined to send as much of that money back to shareholders as possible.

McDonald's last year spent $6.4 billion on dividends and stock buybacks, representing 7% of its market capitalization. P&G delivered $13 billion in capital returns, or 6% of its market cap. That financial commitment to shareholders is one reason why McDonald's and P&G are two of the highest-yielding stocks in the Dow right now, with respective payouts of 3.6% and 3%. But which is the better buy for income investors?

Below I'll make a case for each stock and explain why I think P&G wins this matchup.

The case for McDonald's
McDonald's stock has had a depressing run lately. In fact, it earned a spot on 2015's Dogs of the Dow list for the fourth straight year. The flip side of that underperformance, though, is an unusually high yield. McDonald's is the fifth-highest-paying dividend stock in the Dow, beaten only by telecoms Verizonand AT&T, oil giant Chevron, and conglomerate General Electric.

McDonald's is comfortably ahead of those other companies in terms of raw profit power. Its franchising model produced $8 billion in earnings last year even as comparable-store sales had their worst showing since 2002. Through those struggles, McDonald's operating profit margin held steady at an impressive 30%.

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MCD Operating Margin (TTM) Chart

MCD Operating Margin (TTM) data by YCharts.

Mickey D's has other channels through which it can raise billions of dollars of cash, including selling stores to franchisees and scaling back on capital investments. This flexibility, along with its strong profitability, suggests increasing returns to shareholders even if the fast-food operating funk continues for another year or more.

The case for P&G
Procter & Gamble doesn't have solid profitability going for it right now. Earnings fell by 8% just last quarter. However, that drop can be entirely explained by foreign currency issues. Look under that reported profit dip and you'll see P&G is making big strides in improving productivity. Management is ahead of schedule in its long-term goal of cutting $10 billion out of the cost structure. The latest cuts added 2 percentage points to gross profit margin last quarter, although that could not overcome historic foreign currency moves against the U.S. dollar.

Once exchange rates go back to being a nonissue, investors can expect P&G's cost reductions to supercharge earnings growth. The rebound could be even stronger if management's restructuring plan for the company pays off like it should. Procter & Gamble has already shed dozens of brands while aiming to leave about 75 category leaders with the best potential for growth. The should produce a more profitable company that is much easier to manage.

Source: Procter & Gamble.

To track how that plan is working out, watch organic sales growth. That metric has been a stubbornly low 2% in each of the last three quarters, which isn't high enough to get the job done. P&G intends to implement price increases over the next few quarters, and if they don't lead to volume drops then investors can be more confident that customer demand is on the right track.

Both McDonald's and P&G got in trouble for essentially the same reason: they spread themselves too thin. And both companies are likely to reward shareholders that stick around through these rough times. But for my money, I think P&G is the better dividend investment here. Costs are falling quickly, and management's plan for a leaner business has the potential to combine with those efficiency gains to spark solid profit growth over the next few years.

The article Better High-Dividend Stock to Buy: McDonalds or Procter & Gamble? originally appeared on Fool.com.

Demitrios Kalogeropoulos owns shares of McDonald's and he's a big fan of super-sized dividends. The Motley Fool recommends Chevron, McDonald's, Procter & Gamble, and Verizon Communications. The Motley Fool owns shares of General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.