Retirees are finding it harder to earn a decent return on their savings. For instance, yields on U.S. government bonds are hovering at their lowest levels in more than 50 years. That means income-dependent investors need to look elsewhere to supplement their cash flow in retirement.
Considering a dividend stock instead of a government bond provides a couple of benefits. For one, you can find stocks that pay dividend yields larger than the yields on government bonds. And second, you can find companies that increase their dividend payments over time -- compared to the static payment that a government bond provides.
It's important to remember that companies sometimes decrease or pause their dividend payments -- often when they find themselves in financial difficulty. Therefore, investing in dividend stocks may not be as safe as investing in government bonds.
If you do decide to make the jump and add dividend stocks to help supplement retirement income, two stocks -- Home Depot (HD +3.63%) and Costco (COST +1.28%) -- are worthy of consideration. Here's why.
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1. Home Depot
Home Depot's stock currently pays out a quarterly dividend of $1.65 per share. That means that for every share of Home Depot stock you own, you will get dividend payments of $6.60 per year. That's a return on investment of about 2.08% at the current stock price. What's nice about Home Depot's payout, however, is that this home improvement retail giant consistently increases its dividend.
From 2012 to 2021, Home Depot has increased the annual dividend almost six-fold from $1.04 per share to $6.00. And there is no reason to believe that Home Depot will not continue increasing its dividend through the next decade and beyond, although it may not grow at the spectacular rate it did in the last decade.
Dividends are paid out of a company's earnings, and so you will be glad to hear that Home Depot's earnings per share grew at a compounded annual rate of 19.5% in the last 10 years. That has allowed Home Depot sufficient excess capital to reinvest in its business and increase the dividend payment at the same time. Indeed, Home Depot's payout ratio, which measures dividends as a percentage of earnings, has remained at roughly 45% from 2012 to 2020. That payout ratio is considered to be quite sustainable.
Data source: YCharts.
2. Costco
Costco has an interesting dividend strategy. In addition to paying a regularly recurring dividend, it pays a special dividend once every few years. If you own Costco's stock, the regular quarterly dividend now sits at $0.79 per share. That works out to an annual dividend payment of $3.16 per share. It also represents a 0.79% dividend yield at the current stock price (a yield that is relatively low in comparison to the S&P 500 average). Costco has plenty of free cash flow to maintain these payments as its current payout ratio is a very sustainable 35.7%.
Costco remains popular as a dividend stock because of the periodic special dividends it pays out. In December 2020, Costco paid a special dividend of $10 per share. Before that, Costco paid a special dividend of $7 per share in 2017.
Costco's business prospects have improved during the pandemic. It signed up millions of new members, who pay an annual fee for the privilege of shopping at one of its warehouses. And the company has gained a reputation over decades for providing famously competitive prices. That will make it difficult for any competitor to encroach on its business -- good news for long-term investors looking to ensure that the dividend income keeps coming.
Investor takeaway
Income investors should keep in mind that stock prices are generally more volatile than bond prices. It may very well be the case that your dividend stock decreases in price while maintaining the dividends it paid out over the time of your investment, thereby making your investment a total return loss. That is the risk that comes with looking for income through dividend stocks.
Still, it may be worthwhile to supplement your bonds with dividend stocks like Home Depot and Costco in the current low-interest-rate environment if you maintain a long-term investment outlook. That's because these two stocks have been solid price performers over the long term as well as paying out well on dividends.
