The classic debate in the investment community centers on value stocks versus growth stocks. There are certainly valid arguments to be made for both camps.
However, some investors only care about dividend stocks. The thinking is that owning shares of businesses that have quarterly payouts can provide a steady income stream that can rise over time. This can be a worthwhile strategy.
Costco (COST 1.01%), whose shares are up 130% in the past five years, could be just what dividend-seeking investors, and most quality-focused investors for that matter, are looking for. Is it a screaming buy right now? Let's dive into this top retail stock.
Taking care of shareholders
Costco first started paying a dividend in May 2004, so it has provided nearly two decades of consistent income for investors. Back then, the quarterly payout was just $0.10 per share. This has steadily risen over time and is now at $1.02 per share after management's latest increase. This means the current dividend yield is 0.7%.
Through the first 36 weeks of fiscal 2023 (ended May 7), Costco paid out a total of $799 million in dividends. Based on its net income of $4.1 billion during that same period, the payout ratio was just 19%. This indicates that there is still plenty of room to bump up what Costco allocates toward dividends.
In fact, investors have been rewarded with larger one-time distributions over time. In December 2020, Costco paid a special dividend of $10 per share, after paying $7 per share in May 2017 and $5 in February 2015. It's not a stretch to believe this trend is likely to continue as we look ahead.
Besides currently having a low payout ratio, there's really no threat of Costco facing any financial troubles. The business has proven to be resilient in the face of the coronavirus pandemic, supply chain issues, and high inflation. Consumers will always flock to a retailer that is intensely focused on low prices and high-quality merchandise.
In the past five fiscal years, for example, Costco's revenue and diluted earnings per share have increased at compound annual rates of 12% and 17%, respectively. This helps explain why the stock has performed so well, crushing the broader market.
By also operating a membership-based business model, Costco can drive customer stickiness and loyalty. There were 69 million membership households across the world (as of May 7), up 7% year over year. And in the latest fiscal quarter, the renewal rate in the U.S. and Canada was an impressive 92.6%.
The membership adds a certain level of reliability and predictability to Costco's financial results, which not only can be an attractive characteristic for investors looking for a safer stock to own, but for the management team, too. Executives can better plan the company's capital-allocation policies, like raising dividends and approving bigger one-time payouts, because they have more clarity into the company's near-term outlook.
Looking at the valuation
All of the favorable traits discussed above regarding Costco's dividend, its membership business model, and rising sales and profit will no doubt encourage investors to take a closer look at the stock. After all, this has been a winning investment for years.
But it's also worth considering the valuation. Costco currently trades at a trailing price-to-earnings ratio of 40. That's not cheap by any stretch of the imagination. It's a premium to where shares traded at the start of this year, and it's more expensive than the stock's trailing 10-year average valuation of 33.
This means the current valuation could give investors a compelling reason to be patient for now, adding Costco to the watch list and waiting for a better entry price.
