Income investors can earn a dividend yield of about 2% today by purchasing a diversified index fund that approximates the makeup of the S&P 500. Below, we'll look at a few well-known dividend stocks that pay well below that rate. Costco (COST 0.59%), FedEx (FDX 2.16%), and Ross Stores (ROST 1.35%) each appear to have room for significantly larger dividends, especially when their payouts are stacked up against industry peers.
Costco should bulk up its payout
Costco consistently beats its main rival Wal-Mart (WMT -0.87%) in key operating metrics, including sales growth, customer traffic, and membership loyalty. Yet the nation's second-largest retailer comes up short in the dividend department. Costco commits to pay just $0.50 per quarter to its shareholders, which equates to a 1% yield compared to Wal-Mart's 2%. That gap has been even larger in recent months, but Wal-Mart's surging stock price helped bring it down recently.
The $2 per share in annual dividends that Costco promises translates to less than one-third of the earnings it booked in its most recent fiscal year. Wal-Mart's payout ratio, meanwhile, is much closer to the broader market average of 50%.
Costco's actual dividend payout has been much larger over the last few years as a result of the $8 billion that it delivered to shareholders in a string of special one-time payments. Still, income investors can't count on those windfalls like they can with a steadily growing dividend like Wal-Mart's.
FedEx isn't delivering much income
FedEx is pouring resources into expanding its delivery network, just like its peer UPS (UPS 2.18%). But UPS has found extra cash to send to shareholders despite those major capital requirements, while FedEx hasn't. In fact, its yield is more than three times the 0.7% that FedEx pays today.
FedEx's payout ratio is tiny, as well. The $426 million it paid out in fiscal 2017 amounts to just 14% of earnings.
Shareholders might want to cut FedEx some slack on the size of its dividend commitment, considering the package-delivery giant recently shelled out almost $5 billion on its TNT Express acquisition and is still working through the integration process in that merger. Management appears committed to quickly growing that dividend, too, given the most recent 25% payout hike. Still, that boost wasn't enough to push FedEx to even a 1% yield, so income investors might prefer buying rival UPS.
Ross Stores is about more than just low prices
Off-price retailing specialist Ross Stores pays out 0.8% in yield, or about half that of rival TJX Companies. That dividend amounts to less than 20% of earnings, too, while TJX Companies sends shareholders closer to one-third of its profits each year. This gap has only been increasing lately thanks to big hikes by the TJ Maxx operator, whose payout has more than doubled in five years.
Ross Stores investors have enjoyed some of the biggest stock-price gains in the market over the past decade, as the store base soared from 900 in 2007 to over 1,500 today. At the same time, profit margin has doubled. Management traditionally directs most of those earnings gains toward stock buybacks. It plans to spend $875 million on repurchases in 2017 compared to dividend payments of about $200 million. With its yield lagging far behind rivals, it might be time for executives to direct some of that excess cash toward creating a more substantial dividend commitment.
Each of these companies has kept its payout relatively small despite years of strong profit growth. That track record suggests income investors shouldn't count on big dividend boosts from Costco, Ross Stores, or FedEx, even though the companies can afford to be more generous with their cash returns.