Buying well-run companies and holding them for a period of five-plus years tends to work out well for investors. While stocks can be judged on market sentiment for a while, rock-solid fundamentals can only be ignored by the market for so long.
A $5,000 investment in the high-end home goods retailer Williams-Sonoma (WSM 0.17%) made five years ago would have turned into $11,800 with dividends reinvested, showing that the company possesses the wealth-building ability of a top-notch business. This is significantly better than the $8,500 that the same investment amount put into the S&P 500 index in 2018 would now be worth.
Let's investigate Williams-Sonoma's fundamentals and valuation to better understand the case for buying this stock now.
An eventual recovery is inevitable
Since its founding in 1956, Williams-Sonoma has been tremendously successful. Thanks to the company's heavy investments in its e-commerce platform and well-known premium home brands like West Elm, Pottery Barn, and Mark & Graham, Williams-Sonoma is among the biggest e-commerce retailers in the United States.
| Metric | Q2 2022 | Q2 2023 |
|---|---|---|
| Comparable brand revenue growth rate (YOY) | 11.3% | (11.9%) |
| Non-GAAP operating margin | 17.1% | 14.6% |
| Diluted share count (in millions) | 69.1 | 64.5 |
Data source: Williams-Sonoma. YOY = year over year.
The San Francisco, CA-headquartered company recorded $1.9 billion in net revenue during the second quarter, ended July 30, which was down 12.9% from the year-ago period. Even though Williams-Sonoma caters to high income customers, the current macroeconomic environment is still causing issues. Higher interest rates have led to slower home sales activity.
Moving down the income statement, non-GAAP (adjusted) diluted earnings per share (EPS) fell by 19.4% year over year to $3.12 for the second quarter. The retailer's total expenses shrank at a slower rate than net revenue did, which is how non-GAAP operating margin contracted during the quarter. Williams-Sonoma's lower net revenue base and profitability couldn't be overcome by a meaningful reduction in its share count in the quarter. That is why the plunge in adjusted diluted EPS was more pronounced than net revenue for the quarter.
Image source: Getty Images.
As painful as an across-the-board drop in business is to witness, this is nothing new for a cyclical business such as Williams-Sonoma. As interest rates are eventually lowered and the residential real estate market recovers, the retailer should as well. Analysts anticipate that after this fiscal year ending in January, Williams-Sonoma will again return to earnings growth.
The dividend isn't done growing
Meanwhile, investors can enjoy a good dividend. Williams-Sonoma's 2.5% dividend yield is measurably more than the 1.5% yield of the S&P 500 index. And having more than doubled its quarterly dividend per share over the past five years, the company has demonstrated its commitment to dividend growth.
WSM Dividend data by YCharts
Luckily for shareholders, dividend growth should remain healthy in the years ahead. That is because Williams Sonoma's dividend payout ratio is expected to clock in at around 25% for the current fiscal year. This leaves the company with plenty of funds to mix business investments with share repurchases and dividend boosts.
A modest valuation for an awesome business
Up 23% so far in 2023, shares of Williams-Sonoma certainly haven't missed out on the market rally in recent months. Yet the stock's forward price-to-earnings (P/E) ratio of 9.7 remains well below the specialty retail industry average of 15.5. If that wasn't convincing enough, Williams-Sonoma's trailing-12-month price-to-sales (P/S) ratio of 1.1 is in line with its 13-year median of 1.1. This is why I believe the stock is a buy for dividend growth investors at now.
