What makes a top dividend stock? A high yield probably tops the list. But it's not the only factor, and investors are often better off avoiding stocks with extremely high yields because they can come with a lot of risk.
Other features of top dividend stocks include consistent growth over time, reliability, and strong company performance. A company that's underperforming can't necessarily support a growing dividend.
Passive investors, especially retirees, need to consider all of these factors. If you want reliable, worry-free passive income for the foreseeable future, consider Costco Wholesale (COST -0.89%).
Why Costco is a great stock to own
Costco has a differentiated membership-based retail model that generates sales growth, loyalty, and profits. During the early stages of the pandemic, the company experienced elevated sales growth. In the aftermath, however, Costco went through a sag in sales but its sales growth has returned to prepandemic levels.
In the fiscal second quarter (ended Feb. 18), sales increased 5.7% year over year, driven by a 5.6% increase in comparable sales (comps). Earnings per share rose from $3.30 last year to $3.92 this year.
The membership metrics tell more of its story, though. Household members increased 7.8% year over year, and membership fees increased 8.4%, or by $84 million, to $1.1 billion. U.S. and Canada renewal rates were 92.9%, and global renewal rates were 90.5%.
Shoppers are still holding off on expensive items, but they're doing their essentials shopping at Costco. When inflation rates drop, the company's sales are likely to accelerate.
Why Costco is great for dividend investors
At first glance, Costco's dividend doesn't look very impressive. It yields only 0.57% at its recent price. However, the company has paid a large special dividend five times over the past 12 years, or about every 2.5 years. It just paid its most recent (and largest) special dividend in December for $15 per share.
Adding the special dividend to the full yield puts it in the same league as other top dividend stocks. It's not likely to pay the next one until a similar amount of time passes, but management made it sound like the special dividend is something it plans to keep doing.
Costco sits on a huge pile of cash, padded by its incredible operating model and reliable membership-fee income. Management is keen on giving some back to shareholders, and as it piles up, more special dividends are likely to follow.
As for the quarterly dividend, management has raised it for the past 20 years annually. It's reliable for payment and growth.
Is now the right time to buy Costco stock?
There's a common complaint that Costco stock is too expensive. It trades at a price-to-earnings ratio of 47, which is a rich valuation. It deserves some premium because it's so reliable for growth, but this is close to its highest price-to-earnings ratio ever.
The company's stock has pulled back a bit recently, falling after its second-quarter earnings report. It's trailing the S&P 500 year to date, which is a rarity for this stock.
Costco stock skyrocketed after it announced the special dividend, but investors might realize that it can't support this kind of valuation at current growth rates. However, if you're a long-term investor, the valuation shouldn't put you off. The company should continue to beat the market for decades and provide reliable and growing passive income for dividend investors.
