Why Costco Wholesale Is Not Your Average Dividend Stock

If you're looking for a quality dividend stock to add to your portfolio, it may be easy to skip over Costco Wholesale (COST -0.47%). The big-box retailer pays a dividend yield of less than 1%, which may look a bit bland. But long-term shareholders know that dividend yields can be misleading in this case.

If you had held on to Costco's stock over the past five years, the dividend income you would have received from it would have not only been more than what you would have earned from the average stock on the S&P 500, but its payout would have been the equivalent of a stock yielding more than 3%.

Costco has been increasing its dividend significantly

One of the ways Costco has rewarded its long-term shareholders over the years is through dividend increases. Last week, the company reported its latest dividend, which at $1.16 is 14% higher than the $1.02 it was previously paying. At the start of 2019, the company was paying investors a quarterly dividend of $0.57 -- it has gone on to more than double since then.

Costco's strong results over the years have given it plenty of room to boost its payout. Its payout ratio is less than 30%, which makes it highly probable that not only is the current dividend safe, but that Costco is likely to continue raising it for the foreseeable future.

Meanwhile, the business still looks to be in solid shape, with Costco also reporting last week that its sales for the five-week period ended April 7 were up 7.7% for the total company, with e-commerce being particularly strong and generating a comparable growth rate of 28.3% versus the prior-year period.

The company has also paid special dividends

A dividend is never a guarantee. But when companies start paying them, they create the expectation that they will continue. A special dividend is even less of a guarantee, and it is much more discretionary. But Costco has paid special dividends multiple times in recent years. In 2020, amid some strong results due to pandemic-fueled spending, the company declared a $10 special dividend. And late last year, it announced an even higher special dividend of $15 per share.

The company's tendency to pay a special dividend multiple times is a positive sign to investors that it may continue to do so in the future, particularly if the business does well.

This is how much you would have made from Costco's dividend over the past five years

If you were to have bought Costco's stock five years ago, you would have pay around $245 per share. By investing $10,000 into the retail stock, you would have acquired roughly 40.8 shares of the business. During that time, you would have collected its regular, modest quarterly dividend payment, which rose from $0.65 to $1.02.

But the big impact on your dividend income would have been the two special dividend payments the company issued. Those two alone would have accounted for $25 per share in dividends; they would have generated approximately $1,020 in dividend income.

The other 20 quarterly dividend payments would have generated a total of $663 for you. When combined, your dividend income would have totaled $1,683. To put that into perspective, here's what your dividend income would have been if you'd invested $10,000 in stocks at varying yields (assuming no dividend growth).

Calculations by author.

Even a stock that pays 3% in dividends wouldn't have generated the same level of dividend income as Costco has over the past five years.

Should you buy Costco's stock for the dividend?

The big caveat with Costco's dividend is that the payouts have been inflated due to the special dividends the company has paid in recent years. But I think it's a much smarter strategy for the company to issue a special dividend when it makes sense to do so, rather than to increase the dividend and create a higher, potentially more burdensome expected obligation.

With a special dividend, there's even more discretion for the business to simply declare a big payout when it makes sense to do so. By keeping its yield low, it can focus on growth opportunities without having to worry about high dividend payments, and then reward long-term investors later on when those growth initiatives pay off.

Costco is a great stock to own for more than just its dividend. But this can be an underrated and excellent income stock to buy and hold. While its yield may look underwhelming, this is an investment that can still generate lot of recurring income for you over the long haul.