Starbucks (NASDAQ:SBUX) may not have one of the highest dividend yields on the stock market, but the safety and growth potential of its quarterly payout more than make up the difference.
When searching for a dividend investment, I look for three things.
- Does the company have the earnings to comfortably pay or initiate a dividend?
- Are there ample opportunities to grow earnings over many years to support dividend increases?
- Does the company have a history of shareholder-friendly behavior?
Starbucks satisfies all three with flying colors.
Earnings comfortably support the current payout
The payout ratio is the percentage of earnings paid out as dividends. A lower number implies that the company won't have to cut its dividend if earnings take a short-term hit. It also means that management has room to raise the dividend in the future.
Starbucks has a yield below 1.4%, but a payout ratio around 35%. The yield is low because the stock has performed well over the past year, up approximately 45%. Since the yield is the annual payout divided by the share price, a higher share price leads to a lower yield. Starbucks could bump the payout ratio to the 50%-70% range, but chooses not to because it has better uses for the capital at the moment.
Opportunities for growth are abundant
As incredible as Starbucks' growth story has been, it's far from over. CEO Howard Schultz expects to have more locations in China than in the United States. Locations in the U.S. currently outnumber those in No. 2 market China by more than 6-to-1, and new stores are still being built in the United States, so the opportunity in China is immense.
Starbucks has the best tech platform in retail and is using it to grow revenue and expand margins. Its mobile app, online ordering, and new delivery initiatives should all help the company boost its top and bottom lines in more mature markets such as the United States and Canada.
Tea, food, and nighttime service with alcohol are other tactics that should help the company grow its earnings for years to come. If earnings double and the payout doubles, the payout ratio will stay at 35%, but the cash put in your pocket each quarter will be twice what it is now. If the share price doubles as well, someone looking at the stock will see a sub-1.5% yield, but those who bought today would have a yield on cost of over 2.5%. This is the power of investing in a growing dividend payer.
Management has long been shareholder friendly
Starbucks is a wonderful brand, and I feel most comfortable about my investment because Schultz is in charge. The growth initiatives I've mentioned are the right moves, but eventually even the best companies run out of superior reinvestment opportunities. At that point, shareholders need management that won't "empire build" at the detriment of shareholders' total return -- something I doubt Schultz is interested in doing.
In sum, because Starbucks passes all three of these tests, I consider it to be one of the best "dividend" stocks around.