Image source: Getty Images.
Costco Wholesale (NASDAQ: COST) is famously frugal when it comes to decking out its warehouses. The retailer admits that its locations aren’t elaborate places to shop because, as it notes in its annual report, customers are “attracted principally by the quality of merchandise and the availability of low prices.”
In other words, members don’t mind grabbing merchandise directly off a wood pallet if it means they’ll be getting an awesome value.
That stinginess also seems to apply to Costco’s approach to its dividend. It pays an unusually low yield while promising to return just a tiny slice of earnings to shareholders. Income investors might want to consider Home Depot (NYSE: HD) and Target (NYSE: TGT) to better satisfy their dividend needs.
Here’s how the three dividends stack up against each other.
Dividend comparison
| Metric | Costco | Home Depot | Target |
|---|---|---|---|
| Yield | 1.1% | 2% | 3.1% |
| Last raise | 13% | 17% | 7% |
| Payout ratio | 31% | 43% | 41% |
Data source: S&P Global Market Intelligence.
Home Depot: 2% yield
Like Costco, Home Depot is seeing a slowdown in sales growth right now. Customer traffic is up 2% over the last nine months, or just about half the pace of the prior year. Yet the home improvement retailer isn’t exposed to the brutal price deflation that’s pinching Costco’s results these days. In fact, average spending is rising thanks to a mix of higher prices and increasing demand from deep-pocketed professional contractors. As a result, Home Depot is extending its lead over rivals while Costco’s simply holds steady.
Image source: Getty Images.
There’s a simple structural reason for investors to expect bigger dividend boosts from Home Depot in the years ahead, too: capital spending constraint.
The retailer is largely done expanding its store footprint, having opened just one new location in the U.S. over the last three years. In contrast, Costco plans to spend billions on launching about 30 new warehouses this fiscal year following last year’s near-record growth. It’s no surprise, then, that Home Depot can routinely deliver 50% of its earnings as dividend payments while Costco’s payout ratio stays stubbornly below 33%.
Target: 3.1% yield
Because they’re exposed to big swings in demand as the economy transitions between boom times and busts, retailers don’t generally boast impressive dividend track records. That helps explain why there are just three retailing stocks in the S&P 500 that can claim at least 25 years of consecutive payout increases. Wal-Mart, with its half-trillion dollars of annual sales, makes the cut, and so does Home Depot rival Lowe’s.
Image source: Target.
Target earns its place in that list because of its 45 straight years of dividend raises. The retailer protected that streak even through an expensive failed expansion attempt in the Canadian market that, together with declining customer traffic in the U.S., produced earnings shortfalls in both the 2013 and 2014 fiscal years.
Things are looking up for the retailer lately, though. Sales growth beat management’s expectations last quarter as more shoppers crowded into the aisles. Meanwhile, Target’s focus on core product categories like apparel and home furnishings, where it enjoys a better competitive advantage than in areas like electronics and groceries, is paying off. The retailer boasts a 30% gross profit margin — more than double Costco’s margin.
Sure, Target consistently trails Costco in comps growth. Its reliance on product sales rather than subscription revenue means shareholders will endure more volatility around earnings, too. But the retailer has demonstrated that it will prioritize its dividend payment even during periods of stress on the business. That track record is enough reason, in my view, to consider snapping up Target’s market-thumping yield of 3% over Costco’s far less substantial 1%.
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Demitrios Kalogeropoulos owns shares of Costco Wholesale and Home Depot. The Motley Fool owns shares of and recommends Costco Wholesale. The Motley Fool recommends Home Depot. Try any of our Foolish newsletter services free for 30 days. 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.
