While high-yield stocks may seem more alluring to investors looking to create passive income, looking for smaller, easily funded dividends is frequently the more prudent long-term strategy.
Though the dividend payments may be lighter up front, these lower-yielding stocks often come with smaller payout ratios -- thereby giving them more significant dividend potential over the long term if bought and held.
Today, three Motley Fool contributors will explain why the recent price declines for Starbucks (SBUX -0.42%), Lowe's (LOW -0.16%), and eBay (EBAY 0.43%) could be a perfect opportunity to generate passive income over the long haul.
The returning CEO bought shares; should you?
Bradley Guichard (Starbucks): You'd think that Starbucks is in dire straits by the share price's 33% decline this year. The company does have its share of challenges. (Doesn't everyone in 2022?) However, rumors of its demise are greatly exaggerated.
Meaningful growth for Starbucks has been difficult recently as the U.S. market is highly saturated. China and other overseas markets offer tremendous, but challenging, opportunities. Inflation has brought rising labor and supply costs, and a union push has some investors concerned. The company needs a strong leader right now, and the return of Howard Schultz as CEO could be just the spark the company needs.
Schultz bought Starbucks in 1987 when it had a whopping 11 stores. There are over 34,000 locations now, and Schultz's hand is all over it. Schultz gave up the reins in 2017, but has returned as interim CEO this year. He recently purchased around $15 million in Starbucks stock as a show of confidence.
The fundamentals aren't bad either. Year-over-year sales for the first two quarters of the current fiscal year are up 17%, while operating income is up 12%. Diluted earnings per share have risen 18.5% over the same period.
The company has raised the dividend annually since it began paying one in 2010. But here's the kicker. The dividend yield is nearly at its highest point ever, as shown below.
This yield suggests a couple of things. First, investors recognize that Starbucks is in a challenging situation. But it also could mean that the pessimism has overshot the mark. It's not practical to time a market bottom, so remember that risk-mitigation strategies like dollar-cost averaging are essential.
This is a terrific time for long-term passive income investors to take a long look at Starbucks stock.
Emphasis on professional contractors is paying off
Jeff Santoro (Lowe's): Home improvement retailer Lowe's has been a market-beating investment over the long term. Including dividends, Lowe's beat the return of the S&P 500 by 46% over the past three years, and by 90% over the past five years. However, year to date, Lowe's is down 29% and is trailing the market by 9.4%.
When Lowe's reported its Q1 2022 earnings in April, the results were mixed, but growth in the Pro category was strong. Compared to the year-ago quarter, revenue was down 3% and comparable store sales decreased 4%. This was in line with what the company was expecting, but management noted that an unusually cold start to spring also had a negative effect on results.
Even with this year-over-year decrease, growth in the Pro category remained strong, increasing 20%, on top of 36% in the year-ago quarter. Helping to drive this growth is a newly launched loyalty program that saw better-than-expected adoption rates during the quarter. The company is also expanding its fulfillment capabilities for items that Pros need in higher quantities for their specific type of work.
There were a few other bright spots in the Q1 report. Earnings per share (EPS) increased 9% to $3.51, and gross margin and operating margin improved 74 basis points and 67 basis points, respectively. Management attributed these results to their ongoing productivity improvement efforts, which are clearly paying off.
Lowe's has long been profitable and cash flow positive and has used its excess capital to reward shareholders. Over the past five years, Lowe's has reduced its shares outstanding by 24% and increased its dividend 156%. The dividend yield is currently 1.8%, slightly higher than the market average of 1.7%.
With a price-to-sales (P/S) ratio of 1.3, Lowe's is trading slightly above its average valuation, and for a discount to where it was at the beginning of the year. For investors looking for passive income, Lowe's is a compelling pick considering the friendly shareholder moves the company makes and its position as one of two major players in the home improvement space.
eBay's capital returns are its x-factor for investors
Josh Kohn-Lindquist (eBay): While e-commerce juggernaut eBay doesn't seem to be as captivating an investment as its faster-growing peers, its unique niche and 18 million "enthusiast" buyers give it an unconventional moat.
Falling between Amazon's more commoditized goods and Etsy's handcrafted items, eBay's focus on collectibles, parts (for cars or computers, for example), and certified refurbished items give it a distinctive niche of online sales.
One example of this specialization is the company's plan to roll out its Vault business, allowing card collectors to buy, sell, and even hold trading cards within eBay's Vault. Similarly, the company's sales of collectible sneakers bring in many niche customers, leading to a tidy spillover effect into some of its more common items.
After growing sales by 42% year over year in the first quarter of 2021, eBay saw revenue dip 6% in Q1 2022 as it tried to lap these incredibly tough comps. But, more importantly, its earnings per share only slid 2% over the same time, highlighting the power of its robust share buyback program.
In just the last five years alone, eBay has nearly halved its total shares outstanding, helping lead to EPS growth of 153% over the same time.
To highlight just how powerful this reduction in share count has been, consider that despite raising its dividend by more than 50% since 2019, eBay made the same amount of dividend payments in 2019 as it did over the last year -- thanks to this lower share count.
On top of these buybacks, eBay pays a 1.9% dividend that pairs with a meager payout ratio of 19% -- allowing for plenty of room for future increases.
Trading at just 11 times earnings, the company's price-to-earnings is 33% below its five-year average.
This cheap valuation and its 36% drop in share price year to date should put eBay on passive income investors' radars, especially considering its 26% free cash flow margin and incredible capital returns to shareholders.