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How Safe is Wal-Mart Stores, Inc. Stock and Its Dividend?

By Brian Stoffel – Oct 1, 2014 at 4:30PM

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How healthy is this mega-retailer? You might be surprised.

The size and dominance of Wal-Mart (WMT 0.21%) is simply mind-boggling. The company has over 11,000 locations worldwide, and employs more folks than any other publicly traded company in existence: 2.2 million people. Outside of the United States, Wal-Mart has a significant presence in Brazil, Central America, China, India, Mexico, Argentina, and the U.K.

In a few years, Wal-Mart will likely cross a symbolic barrier and create over a half-trillion dollars in revenue -- a feat that once seemed impossible. Since going public, the company's stock has returned almost 150,000%.

And for any mom-and-pop that's tried to offer the same fare that Wal-Mart has on hand, the lesson has been clear: You simply don't mess with this company.


But while all of this is no doubt good news for those who have been invested with Wal-Mart for years, it means little for those looking into the company's stock and dividend today.

In fact, if you dig a little, you might be surprised by what you find. Read below to find out.

The most important dividend metric
For those nearing or entering retirement, finding solid dividend stocks is of the utmost importance. And when you're investigating the health of dividends, there's no metric more important to watch than free cash flow.

It is, after all, from free cash flow that dividends are paid. For those unfamiliar, free cash flow represents the amount of cash a company puts in its pocket during a year, and subtracts out anything used on capital expenditures.

Here's what Wal-Mart free cash flow situation has looked like since 2009.

There are two ways you can view the chart above. On one hand, Wal-Mart's dividend is very safe. Over the last twelve months, the company has only used 52% of its free cash flow to pay its shareholders. That means that if times get tough, there's a wide margin of safety for maintaining the dividend. And if free cash flow grows, the dividend has lots of room to run.

On the other hand, Wal-Mart's overall free cash flow situation has been widely variable. This has a lot to do with the fact that the company's buildup of inventory can be lumpy -- which investors shouldn't worry about too much.

Still, it begs the question:

How is the company, as a whole, doing?
Wal-Mart is definitely a company at the crossroads. It might surprise many to know that today, it gets well over half of its revenue from the sale of groceries. In fact, $1 of every $4 spent on groceries in America is spent at Wal-Mart.

That's an important differentiator, as both Costco (COST 0.18%) and (AMZN -0.07%) are encroaching on the low-price leader's decades-long territory. One of the most important metrics for investors to watch -- to be able to check and see if Costco or Amazon is gaining ground -- is comparable store sales.

Amazon itself doesn't publish such a metric -- as it doesn't have any physical stores -- but one look at how Wal-Mart is stacking up against Costco and you can see a disturbing trend emerging.

As you can see, Costco is still showing signs of strong growth. That doesn't necessarily mean Costco is far and away a better stock, however. Instead of sales alone, Costco relies heavily on its annual membership dues for profitability. And it's stock currently trades for 28 times earnings, while Wal-Mart's trades for just 15 times earnings.

In other words, Wal-Mart's stock is almost half as expensive as Costco's.

The final word on Wal-Mart stock
There's no definitive word on whether Wal-Mart's stock and dividend are conviction buys. Investors can take solace in the fact that the company's payout is very safe ... for now. But they need to be aware that the company is losing market share and growth has dropped off a cliff.

Wal-Mart is toying with new store designs to further extend its brand into neighborhoods with a smaller store format. The success of this format could play a huge role in the company's success moving forward. Investors need to keep their eyes on such initiatives, as well as comps, to determine for themselves if the stock is worth holding.

Brian Stoffel owns shares of The Motley Fool recommends and Costco Wholesale. The Motley Fool owns shares of and Costco Wholesale. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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