Rising interest rates and the prospects of a slowing economy have pounded growth stocks in 2022. This explains how the tech-heavy Nasdaq Composite crashed 30% so far this year.
But not all Nasdaq stocks fared poorly year to date. Shares of the off-price retailer Ross Stores (ROST -0.36%) eked out a 3% gain to date. This strong performance raises the following question: Is the retailer still a good deal for dividend growth investors? Let's dive into Ross Stores' fundamentals and valuation to find out.
Another high bar for the company to clear
When shopping for clothes and home fashion products, most people are looking for a bargain. With nearly 1,700 stores in 40 U.S. states, the District of Columbia, and Guam, the company's Ross Dress for Less brand is the biggest off-price retailer in the U.S. The store brand offers customers 20% to 60% off specialty store regular prices each and every day. The company also operates 323 dd's Discounts stores in 21 states, with 20% to 70% off the regular prices of discount stores.
Ross Stores generated $4.6 billion in sales for the third quarter ended Oct. 29, which was a 0.2% decline over the year-ago period. Given the headwinds that the company had to battle during the quarter, this was a decent result.
With pandemic-related stimulus circulating around the economy and inflation only beginning to increase in the year-ago period, Ross Stores had to contend with a difficult comparison. Because stimulus money is now dried up and inflation has accelerated, consumers have less discretionary income available to spend.
The company's comparable store sales were down 3% year over year in the quarter, but still 14% higher than two years ago. The only reason Ross Stores' sales were basically flat for the quarter was new stores that opened over the last four quarters.
The company's diluted earnings per share (EPS) dipped 8.3% over the year-ago period to $1 during the third quarter. Due to a 2.9% increase in Ross Stores' cost of goods sold expense category, the company's net margin fell 90 basis points year over year to 7.5% in the quarter. This reduced profitability was only slightly offset by a 0.4% reduction in Ross Stores' diluted outstanding share count for the quarter. That explains how the company's diluted EPS growth rate lagged behind sales growth during the quarter.
As inflationary pressures ease and Ross Stores continues to build upon its store count, earnings should move higher. Analysts anticipate the company will deliver 5.7% annual diluted EPS growth through the next five years.
Image source: Getty Images.
Solid dividend growth can persist
Compared to the S&P 500 index's 1.6% dividend yield, the first impression that an income investor may have of Ross Stores' 1.1% dividend yield is that it is too low. However, it's worth noting that this below-average starting income also includes robust dividend growth potential.
It is projected that Ross Stores' dividend payout ratio for this fiscal year will clock in at less than 29%. Simply put, this leaves the company with the funds needed to open new stores, repurchase shares, and repay debt.
As a result of such a sustainable payout ratio, I expect dividend growth to outpace earnings growth for the medium term. That's why I believe Ross Stores' dividend will grow at a high single-digit to low double-digit rate annually over the next several years.
A quality stock that is still on sale
It appears as though shares of Ross Stores are still a good value for dividend growth investors.
The stock is trading at a Shiller price-to-earnings (P/E) ratio of 32.4. For context, the Shiller P/E ratio takes into consideration the last 10 years of a company's earnings and adjusts for inflation. Because 10 years is typically viewed as a full economic cycle, this is often a useful valuation metric. Ross Stores' current figure is moderately below the company's 10-year median Shiller P/E ratio of 38.6, which makes it a buy in my opinion.
