Buying companies with a strong track record of payout growth tends to work out well for dividend growth investors. This is because consistently hiking a dividend year after year requires a company to sustain a growing business (i.e., sales and earnings growth).
With 18 consecutive years of dividend growth to its credit, Costco Wholesale (COST -0.55%) is a great stock for investors seeking a balance of income growth and capital appreciation. Let's assess the company's fundamentals to better understand why Costco could belong in your portfolio if you are a dividend growth investor.
Costco is executing well
With more than 850 warehouses as of May across North America, Europe, Oceania, and Asia, Costco is a well-known retailer. The company's extensive global presence is what supports its massive $216 billion market capitalization.
| Metric | Q3 2022 | Q3 2023 |
|---|---|---|
| Currency-neutral comparable sales growth rate | 10.8% | 3.5% |
| Total warehouse count | 830 | 853 |
| Net margin | 2.6% | 2.4% |
Data source: Costco.
Costco recorded $52.6 billion in total revenue during fiscal 2023's third quarter (ended May 7), which equates to a 1.9% year-over-year growth rate. This may seem modest for what is thought of as a growth company. But it's important to note that factoring out a 3.2% headwind faced in the quarter relating to gasoline prices and foreign exchange, the company's net sales grew at a mid-single-digit clip.
Costco's top-line growth was driven by the value proposition that it provides to its members: The company's worldwide renewal rate came in at an all-time high of 90.5% for the quarter. Because more consumers are looking to stretch their dollars further in this inflationary environment, Costco's store traffic rose by 4.8% during the fiscal third quarter. This was only partially offset by a 4.2% reduction in the average daily ticket (i.e., transaction value) from weakness in bigger-ticket discretionary merchandise.
The company's diluted earnings per share (EPS) declined by 3.6% over the year-ago period to $2.93 in the fiscal first quarter. Faster growth in operating expenses (2.3%) than in total revenue led Costco's net margin to contract for the quarter. This is how diluted EPS growth lagged total revenue growth during the quarter.
As Costco opens new warehouses and builds its membership base, earnings growth should be solid in the years ahead. Analysts anticipate that the company's diluted EPS could rise by 8.3% annually over the next five years. That's superior to the discount stores industry average annual earnings growth forecast of 5.9%.
Image source: Getty Images.
Costco's dividend growth is just getting started
Costco's 0.8% dividend yield comes in at about half of the S&P 500 index's 1.6% yield. While this isn't particularly impressive to income investors, it's worth noting that the company occasionally pays special dividends to its shareholders as well: The most recent special dividend per share was $10 paid in December 2020. More importantly, Costco's regular quarterly dividend per share has soared by over 200% in the past 10 years to the current mark of $1.02.
COST Dividend data by YCharts
And considering that the company's dividend payout ratio is poised to come in at 27% for the fiscal year ending in August, additional dividend growth should be in the cards. Such a low payout ratio allows Costco to retain the capital needed for growth opportunities and debt repayment. This is why I expect double-digit annual dividend growth from the company over the medium term.
Buy future dips on Costco stock
Shares of Costco have performed very well in the last year, gaining 15% during that period. This has pushed the stock's forward price-to-earnings (P/E) ratio up to 32.7, which is well above the discount stores industry average forward P/E ratio of 21.8. But taking Costco's above-average growth potential into account, now is a reasonable time to open a position in the stock with the mindset of adding on any pullbacks or corrections.
