Is Costco Wholesale Corporation (NASDAQ:COST) A Smart Pick For Income Investors?

Dividend paying stocks like Costco Wholesale Corporation (NASDAQ:COST) tend to be popular with investors, and for good reason – some research suggests a significant amount of all stock market returns come from reinvested dividends. If you are hoping to live on the income from dividends, it’s important to be a lot more stringent with your investments than the average punter.

While Costco Wholesale’s 0.9% dividend yield is not the highest, we think its lengthy payment history is quite interesting. There are a few simple ways to reduce the risks of buying Costco Wholesale for its dividend, and we’ll go through these below.

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NasdaqGS:COST Historical Dividend Yield, September 28th 2019
NasdaqGS:COST Historical Dividend Yield, September 28th 2019

Payout ratios

Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable – hardly an ideal situation. Comparing dividend payments to a company’s net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Costco Wholesale paid out 29% of its profit as dividends, over the trailing twelve month period. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Of the free cash flow it generated last year, Costco Wholesale paid out 39% as dividends, suggesting the dividend is affordable. It’s positive to see that Costco Wholesale’s dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

With a strong net cash balance, Costco Wholesale investors may not have much to worry about in the near term from a dividend perspective.

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well – nasty. Costco Wholesale has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was US$0.64 in 2009, compared to US$2.60 last year. Dividends per share have grown at approximately 15% per year over this time.

Dividends have been growing pretty quickly, and even more impressively, they haven’t experienced any notable falls during this period.

Dividend Growth Potential

While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend’s purchasing power over the long term. It’s good to see Costco Wholesale has been growing its earnings per share at 12% a year over the past five years. A company paying out less than a quarter of its earnings as dividends, and growing earnings at more than 10% per annum, looks to be right in the cusp of its growth phase. At the right price, we might be interested.

Conclusion

To summarise, shareholders should always check that Costco Wholesale’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Firstly, we like that Costco Wholesale has low and conservative payout ratios. We like that it has been delivering solid improvement in its earnings per share, and relatively consistent dividend payments. Costco Wholesale has met all of our criteria, including having strong cash flow that covers the dividend. We definitely think it would be worthwhile looking closer.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 22 Costco Wholesale analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.