2022 made clear that the long-running bull market of the prior decade is over. In the current volatile economic atmosphere, traders and investors have been piling money into safer stocks, including dividend stocks. Dividend stocks offer some cushion during rough times because investors still derive some benefit from dividends, which provide passive income regardless of stock price movements (unless a severe economic swing results in a dividend cut or suspension). The dividends also tend to make the trading of those stocks less volatile.
Heading into 2023, there's one dividend stock that stands out for me as a great one to own, although many investors don't think of it as a dividend stock. Costco Wholesale (COST -0.24%) has been a steady winner in stock price appreciation over many years, and it's well-positioned to keep gaining this year and beyond. It also happens to pay a nice dividend.
Why Costco's model works
Costco charges its shoppers an annual fee for access to its warehouse of (often discounted) goods for sale. For most people, the yearly savings they get from shopping at Costco instead of at other retail outlets far exceeds the price of the membership. Costco enjoys the recurring revenue stream from these annual fees that basically go straight to the bottom line, with a small markup on products to cover most of its expenses.
The model is compelling and Costco continues to rack up revenue and widen its customer base by millions annually, including in the current inflationary environment.
Consider how it performs when compared with its largest competitors. Its gross margin is substantially lower than those of other supermarket chains such as Walmart, Target, and Kroger.
COST Gross Profit Margin (Quarterly) data by YCharts
Yet, its revenue is growing at a rate that looks unbeatable.
COST Revenue (Quarterly) data by YCharts
Where Costco has room to grow
Prior to the pandemic, Costco demonstrated slow but steady year-over-year comps growth, typically in the mid-single digits. Since the pandemic started, that has revved up to consistent growth in the mid to high teens.
That comps growth finally began to slow down in September, and it slipped further in October to a 6% comps increase over last year. Although it's showing signs of capitulating to inflation, when even shoppers who are doing their essentials shopping at the cheapest prices are reining in spending, part of the slowdown was actually due to the strong dollar.
The other part of Costco's growth model is its slower store opening process. Costco opens new warehouses at a rate of about 25 to 30 per year, which is fairly low compared with other chain stores and gives a long, healthy growth runway. It operates 842 stores as of the beginning of this month, with 579 in the U.S. Compare that with Walmart's more than 10,000 global locations and Target's nearly 2,000 U.S. locations.
The growing dividend
Costco's dividend doesn't appear to be anything amazing at first glance. It only yields 0.67% at the current price. But the company has raised it annually for the past 18 years.
It also issues an occasional generous "special" dividend that makes Costco's dividend worthy. Most recently, it issued a $10 per share special dividend in 2020, when it was flush with cash from soaring pandemic sales. Averaged out, that raises its yield significantly, putting it in league with some of the highest-yielding stocks. Considering how much the stock itself has gained over time, Costco is an incredible provider of shareholder value.
Should Costco's valuation matter?
Costco stock should be a no-brainer buy, but its valuation often sparks discussion. It trades at a price-to-earnings ratio of 41 at the current price, which is far from outrageous, but it's higher than those of similar companies, such as the ones mentioned above (except for Walmart).
Investors are paying a premium for Costco stock because it offers such reliable growth potential. It performs well under pressure, posting some of its best growth under rough circumstances. As we continue to experience a volatile economy, Costco is my favorite dividend stock heading into 2023, and it should continue to reward investors for decades.
