A steadily growing dividend is nice to have as part of any stock investment. But at the very least, income investors want to feel confident that their payout isn't at risk of being suspended or sharply reduced. As GE owners learned recently, any dividend -- even one that's paid by one of the biggest businesses on the market -- could fall victim to a surprise cut.
Below, we'll test the dividend strength of another massive business, Wal-Mart (WMT 0.70%), and look at why shareholders have no reason to fear a cut like that anytime soon.
This dividend goes way back
The retailing titan has raised its dividend in each of the last 44 years. No, that's not the longest streak in the industry. Lowe's, for one, boasts a 56-year record and Target has hiked its payout 50 consecutive times.
Image source: Wal-Mart.
Yet Wal-Mart's dividend record still spans a wide range of operating conditions that includes the global recession in 2008-2009. Thus, shareholders can be reasonably confident that its finances can withstand almost any financial or economic shock.
At the same time, a multidecade track record like that tends to sharpen management's focus on protecting and extending the dividend growth streak. After all, no CEO wants to preside over Wal-Mart's first payout cut as a public company. Instead, executives prefer to be good stewards of capital. "I'm proud of Wal-Mart's long record of shareholder returns," Chief Financial Officer Brett Biggs told investors in the company's 2016 shareholder letter .
Room to grow
Wal-Mart's payout is backed by an ample cushion of both profits and cash. Its $2-per-share dividend payment in fiscal 2017 represented less than half of the $4.38 per share that the retailer generated in earnings. That coverage is even stronger when you look at free cash flow, which has been above $15 billion in each of the last three fiscal years while the dividend commitment is just $6.2 billion.
WMT Payout Ratio (TTM) data by YCharts.
Still, the earnings payout ratio has been climbing recently even as dividend growth slowed. Wal-Mart's current 50% earnings payout is significantly higher than the 38% it reached in 2014. That's because net income has declined over the past two years as the retailer spent aggressively on improving its in-store experience and building out its e-commerce shopping and delivery infrastructure. The retailer's payout ratio is still about average, and nowhere near concerning levels of 70% or more, but it's worth investors keeping an eye on in case it continues to climb much above 50%.
What to watch
Wal-Mart's spending initiatives have helped produce a decent improvement in operating trends lately. Customer traffic rose by 1.5% in the most recent quarter while Wal-Mart's digital sales channel enjoyed a 50% revenue spike. Income investors must hope that this positive market share momentum eventually returns the company to a path of consistently expanding earnings. Otherwise, they're likely to see weak dividend raises in the future that track closer to the 2% hikes that Wal-Mart announced in each of the last three fiscal years.
Ultimately, the dividend is backed by a formidable track record and an annual earnings haul that would make a cut unlikely in all but the most dire economic circumstances. Investors have to weigh that stability against the prospect for tiny annual raises ahead, should Wal-Mart fail to adapt to changing shopping behavior as e-commerce eats up an increasing proportion of the traditional retailing industry.
