Since income investors are typically looking to buy shares of stable businesses with proven track records for their portfolios, it makes sense to consider stocks with decades of dividend increases under their belt.
One stock that has rewarded shareholders with steady payout growth for decades is Lowe's (LOW -1.70%). With 59 consecutive years of dividend increases, Lowe's is a Dividend King, putting it in the enviable company of just 30 other stocks that also hold this title.
Lowe's has seen its stock price surge about 30% year to date, easily outperforming the broad market. So, is Lowe's still a buy after this impressive rally, or are investors better served waiting for a correction before picking up the stock?
Tremendous operating results and growth catalysts
Many companies struggled in the early months of the COVID-19 pandemic but not all of them.
Lowe's was one business that held up well even as people stayed home to slow the spread of the coronavirus. For a company that was already benefiting from favorable demographics (i.e., more millennials buying homes and investing in their homes with renovations) prior to the pandemic, COVID was like fuel to the fire.
This explains how Lowe's net sales jumped 24% from $72.1 billion in fiscal 2019 to $89.6 billion in fiscal 2020. And Lowe's was also able to expand its net margin by nearly 60 basis points to 6.5% last year. Those two factors, plus a 5% decline in outstanding shares, led adjusted diluted earnings per share (EPS) to soar 54% to $8.86.
And lest anyone think that its momentum couldn't continue beyond 2020, Lowe's has succeeded in proving the naysayers wrong through the first half of fiscal 2021. Lowe's grew sales in this period 11% year over year, adding to its gains from the start of the pandemic. The trifecta of higher sales, expanding margins, and a reduced share count again resulted in strong earnings growth of 36% for the half.
Management's guidance for 2.7% sales growth in fiscal 2021 implies a moderate slowdown in the second half of the year. But even with that being the case, the company's discipline with costs and share repurchases (management plans to repurchase at least $9 billion of shares in the current year) is expected to result in adjusted EPS growing 28%.
Taking a step back, existing-home sales declined 2% from July to August, but the housing market remains incredibly strong. The median price of an existing home sold last month increased 14.9% year over year to $356,700, due in large part to a lack of supply. This priced out many first-time home buyers and contributed to the decline in sales.
Fortunately, new residential building permits rose 6% from July to August, hitting over 1.7 million. Ongoing activity in this sector should help to reduce the shortage of 3.8 million single-family homes in the U.S., in turn translating to solid demand for Lowe's going forward.
An incredible balance sheet
Strong operating results and tailwinds are one thing, but will Lowe's be able to hold up if the housing market abruptly heads south?
Looking at its balance sheet, the company has $6.3 billion in cash and short-term investments but $24.3 billion in debt. This might seem like a red flag at first glance, but if we turn our attention to the interest coverage ratio -- which tells us the extent to which a company can cover its interest expenses with earnings before interest and taxes (EBIT) -- the situation becomes clearer.
Through the first half of fiscal 2021, Lowe's interest coverage ratio improved from an already robust 10.1 at the end of last year to 11.9. Put another way, Lowe's EBIT would need to fall over 90%, interest expenses would need to skyrocket, or some combination of the two would need to occur for the company to be unable to cover its debt obligations.
This means Lowe's has plenty of breathing room on its balance sheet, even if market conditions worsen, which should help conservative investors sleep well at night.
Lowe's is royalty at a pauper price
But even with Lowe's healthy outlook and secure balance sheet, it's important for investors to insist on paying close to fair value. This allows an investor to receive a higher starting yield while limiting their downside risk in a market correction. Fortunately, Lowe's appears to be a Dividend King trading at a discount.
Lowe's trailing price-to-earnings (P/E) ratio of 21.4 is slightly below its historical median of 22.1, and the company's fundamentals are arguably the strongest they have been in years. Compared to the S&P 500, which trades for 35 times trailing earnings, Lowe's attractive value becomes even more obvious.
Put it all together, and despite its strong stock performance year to date, Lowe's is positioned for further upside in the years ahead while also rewarding investors with a reliable, above-average yield of 1.5%.