There are a lot of things to consider before buying
an interest in a publicly traded company. These considerations
include the company's business model, potential for future earnings
growth, and corporate governance. Another important consideration
for many investors is the dividend. Dividends are great, because not
only can they provide investors with a little bit of cushion to the
downside, but they are also used by management as a way to
communicate its confidence in the company's future.
Today, let's look at the
dividends from three of the biggest players in the retail sector: Wal-Mart, Target,
Let's see how the dividends from these three companies stack up in
terms of strength, sustainability, and future potential.
The most obvious consideration when comparing
dividends from different companies is the dividend yield, which
represents the percentage of your investment that you receive back
over the next 12 months, provided that the dividend doesn't change
over that time.
Table 1: Dividend Yields of Wal-Mart,
Target, and Costco
Target has the strongest dividend at this point in
time, when it comes to dividend yield.
It's not all about the dividend yield when it comes
to the strength of the company's dividend. If the dividend doesn't
grow, then its purchasing power will be reduced over time due to the
effects of inflation. If a company does not increase its dividend
over time, then that could signal that management isn't as confident
in the company's future. For these reasons, income investors like to
see companies that not only pay strong dividends, but dividends that
are increased on a regular basis.
Table 2: Five-Year Average Annual Dividend Growth Rates From Wal-Mart,Target,
Table 2 shows impressive double-digit dividend growth
rates for all three companies that easily outpace inflation.
However, it should be mentioned that Wal-Mart's
most recent increase was by only 2.1%, after an 18.2% increase
during 2013. Target's most recent increase was by 19.4%, which is
steady with the 20% increases in both 2011 and 2012. Costco's most
recent dividend increase was 12.7%, which is inline with what the
company has done over the last 5 years.
It should be mentioned that Costco's
figures do not include the one-timespecial
$7 per share that was paid out in 2012 due to worries over taxes
ahead of the "fiscal cliff" debacle. The dividend growth figures
above only deal with regular quarterly dividends.
Wal-Mart has increased its dividend every year for
the last 41 years, while Target has increased its dividend every
year for the last 46. For this reason, these two companies are on
the list of S&P 500 Dividend Aristocrats, an elite group of
companies who have increased their dividends for at least 25
consecutive years. Costco has increased its dividend every year for
the last 10 years.
In terms of past overall dividend growth, Target wins
Free Cash Flow Payout Ratio
While it's nice to see high yields and strong
dividend growth rates, we need to make sure that the company in
question is generating enough free cash flow to keep the dividend
payments going. For this reason, I like to calculate the free cash
flow payout ratio, which is the percentage of free cash flow that is
eaten up by dividends over a given period of time. Lower free cash
flow payout ratios are better as they leave more room for other
activities as well as for future dividend increases.
Free cash flow is basically the cash flow a company
generates in its operations minus capital expenditures required to
maintain or expand the business.
Table 3: Free Cash Flow Payout
Ratios of Wal-Mart, Target,
Table 3 shows that none of the dividends from these
three companies appear to be in any sort of danger. These three
companies are currently generating more than enough free cash flow
to cover their dividend payouts.
payout ratio ballooned out to 67% from 46% a year ago, due in large
part to the company's 18.2% dividend hike in 2013. From now on, its
dividend growth will need to more or less match its earnings growth.
Costco's 4-year average free cash flow payout ratio is very high due
to that huge special dividend mentioned earlier. In the years before
that, the payout ratio was about 20%. Both Target and Costco can
still use the expansion of their free cash flow payout ratios, along
with earnings growth, to increase their dividends.
Earnings Per Share Growth Forecasts
While it's good to look at what past dividend payouts
have been and how they relate to past earnings, we need to get an
idea as to what future dividend payouts are going to look like. One
of the ways in which we do this is by looking at analyst forecasts
for earnings-per-share growth.
Table 4: Earnings Per Share
Growth Forecasts For Wal-Mart, Target,
From Table 4, Target looks like it's going to grow
profits at a much faster rate than both Wal-Mart
All three of these retail companies have strong
dividends that are more than supported by free cash flow. With an
elevated free cash flow payout ratio, resulting from its large
dividend increase last year, Wal-Mart
should continue to increase its dividend at a low to mid
single-digit rate if the analyst estimates hold true. Costco is only
expected to grow earnings at 3% this year, but with a free cash flow
payout ratio of just 38%, it should have no problem continuing to
increase its dividend at a double-digit rate. However, its current
yield is so small, that it is all but negligible for most investors,
especially when compared with yields on cost that you can achieve
with Wal-Mart or Target
if current dividend growth rates prevail for several more years.
Target, meanwhile, has the highest yield and the
highest dividend growth rate. With earnings per share expected to
grow at an annual rate of over 20% for the next couple of years,
along with a free cash flow payout ratio of just 33%, it is my
opinion that Target's dividend has the best prospects of the three.