Costco Wholesale (COST -0.82%) is building up its cash as it continues to post higher sales than before the pandemic and manages to keep costs low enough to increase net income. It's a winning strategy that makes it a cash machine, and it shares its cash with shareholders in the form of dividends and share-repurchase programs.
In addition to its regular dividend, which is unexceptional, Costco issues a "special" dividend when the cash box is overflowing. That dividend is quite exceptional, and one might be coming your way if you own shares or if you buy shares in time.
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What is a special dividend?
Costco began to issue a dividend in 2004 and has raised it every year since. It issued its first special dividend in 2012 for $7. In total with its regular quarterly dividend, it issued $8.065 in dividends in 2012, which yielded a whopping 8.48% at the price at the end of 2012. It issued another special dividend for $5 in 2015, again in 2017 for $7, and the most recent special dividend for $10 in 2020, when the pandemic started and sales growth began to highly accelerate. At that time, CFO Richard Galanti said:
This special dividend, our fourth in eight years, is our latest step to reward shareholders. Our strong balance sheet allows us to pay this dividend, while preserving financial and operational flexibility to continue to grow our business globally. Costco will continue to be in a financial position to take care of our employees, enhance the value of the Costco membership, and create shareholder value over the long term.
When it issued the special dividend in 2017, it had under $5 billion in cash, and when it issued the 2020 special dividend, it had more than $12 billion in cash. As of Feb 13, it has nearly $12 billion in cash, or about double its typical pre-pandemic cash balance.
Galanti said that the end of the second quarter is usually when it has its highest cash balance since it has high seasonal sales and less debt. But management is aware of the balance and considering how to play it. "We've done four specials," he said. "We are a little quirky, and it seems to have worked for us. So it's certainly an arrow in our quiver, but we haven't made any decision at this point."
What to do with all that cash?
Galanti said that right now management is focused on corporate expenditures. Plus, between opening new stores and navigating supply-chain disruptions, it's not at a loss for where to spend money. However, sales are still elevated and Costco's cash position is still building.
It seems more likely that as operations stabilize, whether in the new consumer norm or reverting to the old norm, management will consider another special dividend. So while it probably won't happen immediately, it could well happen in the near term. In the meantime, Costco announced a regular cash dividend of $0.79 in January.
The stock yields 0.6% at the current price, which is Costco's standard, not-very-high yield. But there's more to that than meets the eye. Costco's payout ratio is fairly low, in line with its strategy to invest in growth and operations. It's at about 25% right now, leaving most of the cash in management's hands to open new stores and improve operations.
In that sense, Costco's unusual strategy of keeping the payout ratio and dividend yield low -- but padding what it gives to its shareholders with the occasional special dividend -- seems like a very smart move. There aren't expectations of a high quarterly dividend, which could drain it of the cash it needs to stay flexible and expand. But when it does have extra cash, it makes up for the otherwise low dividend. Shareholders benefit from the extra income and also from owning stock in a company that's investing in growth.
And it's been lucrative to own Costco stock. It's outperformed the broader market over time, and its compelling model makes it a no-brainer stock to have in your portfolio. If you don't own shares yet, you should consider opening a position before management issues the the next special dividend, which could be within the next year.
