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Is Wal-Mart a Good Dividend Investment?

By Nicholas Rossolillo - Apr 15, 2016 at 6:18PM

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In the search for solid dividend payers, should investors pass on shares of the world's largest general store?

Image source: Wal-Mart.

Wal-Mart's (WMT -2.74%) growth has come to a screeching halt in the past year. With the king of retail's future in question in a world that's gravitating to online shopping over the in-store experience, investors would be excused for wondering whether Wal-Mart can increase its dividend going forward. This thought was reinforced when the company boosted its dividend back in February by a meager 2%.

Can Wal-Mart keep the cash spigot running?
For investors interested in income, not only is the stability of the dividend important, but increases to that dividend over time are also key. The cost of living rarely decreases, so a company that pays out an increasing amount of cash can help offset inflation. Wal-Mart is an example, increasing its payout for the 43rd year straight back in February, when it boosted its dividend from $1.96 to $2.00 for the coming year.

But are future increases realistic to expect? And if so, how much of an increase can investors look forward to? To answer this question, I like to use the sustainable growth rate (SGR) for dividend-paying companies such as Wal-Mart. Here's how we calculate SGR:

SGR = return on equity × (1-dividend payout ratio)

A company's sustainable growth rate measures how much a company can grow each year without borrowing money. This is important to consider, because this rate measures the growth in profit the company can generate. These profits are used to reinvest back into the business as well as to potentially reward investors with increasing dividends.

From Wal-Mart's last earnings report, we learn that ROE is at 17.8% over the past year and the company retained 57.1% of earnings. Multiplying the two numbers gives us a sustainable growth rate of 10.2% for Wal-Mart, a respectable rate of growth for a business of its size. The worldwide retailer's dividend is not only safe, but increases are also sure to be in order with that type of expectation.

A sampling of analyst expectations on Yahoo! Finance, though, has Wal-Mart's average earnings growth each year over the next five years at 0. Should such a discrepancy between SGR and analysts be concerning?

I believe the market is being overly pessimistic about the company's prospects going forward. Admittedly, it's been a tough year for old-school retail, which has had to fight a slew of online players, including and eBay, as well as newcomers such as Etsy. Other traditional retailers have also been investing in their own online presence, further crowding the growing e-retail industry.

Wal-Mart has also had the extra challenge of dealing with rising wages for employees and a strengthening U.S. dollar, the latter of which decreased the value of its revenue earned overseas. As a result, many analysts have practically written off the megastore's potential.

An important consideration
It's easy to get lost in the pessimism that surrounds brick-and-mortar retail in general. But I think analysts and investors are missing a few key points when considering the ability of a company like Wal-Mart to adapt to changes in business.

The first we've already touched on briefly: retained earnings. Wal-Mart turned a profit of nearly $14.7 billion in 2015, $8.4 billion of which it retained. This is cash that can be invested for future growth of the business. Over the course of the year, Wal-Mart invested $10.7 billion back into its business. The company's calculated return on investments and return on assets was 15.5% and 7.5%, respectively. While these numbers may not be setting the world on fire, they also certainly don't paint the picture of a company that will have zero profit growth over five years. And for our purposes of dividend growth consideration, the fact that the company is able to generate positive cash from assets and invested funds bodes well for those looking for a strong dividend payer.

With ample room to cover its current payout, retained earnings that can be invested for the future, and a long-term annual growth rate pushing 10%, Wal-Mart should be able to offer dividend increases averaging in the mid-single digits over time. For those looking for stocks that provide income, and the potential to increase that income with dividend hikes, I think Wal-Mart is a solid addition to a portfolio.

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