Costco's (COST 0.05%) dividend isn't as tiny as it looks. Sure, any finance website will tell you that the stock yields about 1%, or far below peers like Target (TGT 0.33%) and Wal-Mart (WMT 0.66%) with their 4% and 2.5% respective yields. Costco promises to pay out just $2 per share of dividends each year, for a far lower proportion of earnings than these rivals.
Long-term shareholders have collected higher yields in practice, though, including from the $7-per-share one-time dividend that Costco issued in late May. This single payout equates to nearly four years of dividend payments that you would have received just through its stated $0.50-per-share quarterly commitment.
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While management calls these surprise income events "special" dividends, they happen with some regularity. Costco in 2015 paid out a $5-per-share one-time dividend and delivered another $7-per-share bonus in late 2012. Altogether, the company has issued $8.3 billion in special dividends in the past few years, or about 3.5 times its most recent annual earnings haul.
As a shareholder, I'm not going to turn down these lumpy payouts. But I'd prefer the company boost its regular commitment over relying on these unpredictable, surprise dividends.
Keeping it regular
Target and Wal-Mart each promise to send roughly half of their earnings back to investors in the form of regular dividends. Costco's commitment is a far less generous 31%. As a result, Costco's yield is lower than these industry peers and also about half the rate that an investor could receive just by owning a total stock market index fund.
TGT Payout Ratio (TTM) data by YCharts.
Costco's management would likely prefer to avoid a bigger dividend because lower payouts give Costco added financial flexibility. And it's true that the company needs plenty of cash right now since it is aggressively expanding its store base including into international markets. Yet Wal-Mart is ramping up spending on everything from labor to improving in-stock levels at stores to bulking up its online presence. The retailing giant still has no problem committing to a significant, consistent dividend payment for its shareholders.
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Meanwhile, Costco's earnings are far more stable than any of its other industry peers. It generates most of its profits through membership fees, not product sales, and these club fees don't swing around with small changes in economic growth trends. They've also helped net income more than double over the past decade.
A better way
Given that rock-solid financial profile, Costco could take a page out of Home Depot's playbook. The home-improvement retailer recently responded to its streak of improving operating trends by raising its dividend commitment to 55% of earnings from 50%. Sure, management could have waited a few years and then surprised its shareholders with a large one-time payment. But one of the most attractive aspects of a dividend is its predictability. And now, income investors can count on significantly higher payouts from Home Depot with every passing quarter.
This latest $7-per-share special dividend doesn't send Costco shareholders the same comforting message. Instead, it signals that their company's dividend policy will continue to be more volatile than it needs to be.
