There are few guarantees in life. But investing in quality dividend stocks is close to a surefire way to build wealth over the long run. Since quality is a subjective term, you're probably thinking of the following question: What is quality?
To me, quality is a company whose revenue and earnings consistently move higher over time. This higher revenue and earnings base is what leads stocks to grow in value as the years progress.
The dollar store retail chain known as Dollar General (DG 1.94%) is a quality dividend growth stock, in my opinion. For instance, a $10,000 investment into the retailer made 10 years ago would now be worth $61,000 with dividends reinvested. For context, this is nearly double the $33,000 that the S&P 500 index would have parlayed the same investment amount into after 10 years.
Past performance is no guarantee of future results. But in the case of Dollar General, I am confident that the stock's total returns can continue to leave the S&P 500 in the dust. Let's dig into the reasons why.
1. The fundamentals remain enviable
Dollar General was founded in 1939 with the mission statement of serving others. And the company has done just that, thanks to its strategy of offering low prices to customers on essential items like housewares, food, snacks, and health and beauty aids from America's most dependable brands. Dollar General's U.S. leading store count of 18,818 as of Oct. 28 also provides jobs to more than 173,000 employees and opportunities for career advancement.
The discount retailer's net sales increased 11.1% year over year to $9.5 billion in the third quarter. How was a large-cap company such as Dollar General able to pull off a double-digit topline growth rate?
The company's same-store sales grew 6.8% over the year-ago period during the quarter. This was due to elevated inflation and a more uncertain economic outlook, which led to a modest increase in customer traffic, according to chief executive officer Jeff Owen. When coupled with a 5% increase in the ending store count, this is what propelled net sales considerably higher for the quarter.
Dollar General's diluted earnings per share (EPS) surged to $2.33 in the quarter, which was a 12% year-over-year growth rate. Because the cost-of-goods-sold expense category grew at a faster clip than net sales (11.6%), the company's net margin fell by nearly 20 basis points to 5.6% during the quarter. But this was more than offset by a 3.6% decline in Dollar General's diluted outstanding share count for the quarter. That explains how the company logged higher diluted EPS growth than net sales growth in the quarter.
As Dollar General makes its way into more communities and offers more products (i.e., basic groceries via DG Fresh and healthcare goods through DG Wellbeing), profits should also expand. This is why analysts are expecting 11.1% annual diluted EPS growth for the next five years. Putting this into context, that's a significantly better growth rate than the discount stores industry average of 6.9%.
Image source: Getty Images.
2. A sustainable payout with plenty of room for future growth
Dollar General's 0.9% dividend yield will seem boring to income investors alongside the S&P 500 index's 1.7% yield. However, the stock's yield is deceptively low.
This is because, with the dividend payout ratio set to come in around 20% for the current fiscal year, there is ample flexibility for high dividend growth moving forward. Dollar General is retaining more than enough capital for new store openings, share repurchases, and debt reduction.
This is why I believe that the dividend will grow moderately ahead of earnings through the next few years, which could result in low-teens percentage dividend hikes over that time. In my opinion, this compensates for the low starting income that Dollar General provides to its shareholders.
3. The stock is a great value
As a result of its defensive nature as an investment, Dollar General's stock has managed to gain 4% year to date amid a down market. But even now, the stock arguably remains a buy.
Dollar General's forward price-to-earnings (P/E) ratio of 19.5 is below the discount stores industry average forward P/E ratio of 22. And if anything, the stock's valuation deserves to at least be in line with its industry or slightly higher by virtue of its superior growth potential.
