What's Fueling Costco Wholesale Corporation's Delightful Dividends?

By Markets Fool.com

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Source: Motley Fool.

Costco is not a particularly popular name among dividend investors, but the company's recent dividend news might impress the naysayers.

On Jan. 30, Costcoannounced a new special dividend of $5 per share, payable on Feb. 27 to shareholders of record as of Feb. 9.At current prices, the new special dividend payment represents a generous dividend yield of 3.4%. In addition, Costco pays $0.355 in quarterly regular dividends, which represents another 1% dividend yield for shareholders.

But what's driving this shareholder value? Let's check out the company's fundamentals and financial strength to see if Costco can sustain paying increasing dividends over the coming years.

Growing cash flows from Costco
Costco's management has been committed to rewarding shareholders for years via growing cash flows.

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This is not the first time that Costco has paid a special dividend. In 2012, the company distributed $7 per share in special dividends in anticipation of an increase in dividend taxes.

And when it comes to regular dividends, Costco has raised payments every year since making its first distribution in 2004.What started as a quarterly payment of $0.10 per share back then has rapidly increased to $0.355, and the company has hiked dividends at more than 14% per year over the last five years.

Looking ahead, the business is unquestioningly solid from a financial standpoint which suggestsCostco has considerable room to continue increasing dividends over the coming years. Costco presently has more cash and liquid investments than debt on its balance sheet, and it generates abundant cash flows on a recurrent basis. In fact, regular dividends consumed approximately 27% of free cash flows last quarter.

A high quality business
Costco's warehouse retail business model offers a strategy which resonates remarkably well among consumers and offers some important advantages for investors. The company makes most of its profits from membership fees, as opposed to margins on sales, which allows Costco to charge amazingly low prices for its merchandise and keep its customers happy and coming back for more.

And Costco's customers are quite loyal. Renewal rates have been consistently above 85% over the last several quarters, reaching 87.3% on a global basis during the quarter ended in November. According to data from the American Customer Satisfaction Survey, Costco is the best-ranked company in the industry with a satisfaction rank of 84 versus an industry average of 80.

Investors can delight in Costco's business model. Because profits are not overly dependent on sales volume and instead come from subscription fees, this model provides stability and predictability to the company's cash flows -- a key concern when evaluating a company's ability to consistently raise dividends over time.

Beating the competition
Happy customers translate into happy shareholders when it comes to Costco. The company has materially outgrown competitors such as Wal-Mart and Target over the last several years.

COST Revenue (TTM) Chart

COST Revenue (TTM) data by YCharts

There is no reversal in the trend either, according to recent financial reports. Costco announced a vigorous increase in same-store sales of 7% when excluding foreign exchange and fuel price fluctuations during January. Wal-Mart does not report monthly sales, but the company announced that total comparable sales excluding fuel rose by a much more moderate 0.5% during the 13-week period ended in October. Similarly, Target announced a 1.2% increase in U.S. segment comparable sales during the last quarter.

In a stable and mature industry such as discount retail, one company's gains are usually another's losses, so investors need to pay special attention to the competitive dynamics in the industry in order to bet on the winning players.Interestingly, both Wal-Mart and Target have built impressive track records of dividend growth over the decades: Wal-Mart has raised dividends over the last 41 consecutive years, while Target has 47 years of uninterrupted dividend growth under its belt.

But as a more dynamic growth player in the industry, coupled with extraordinary fundamental quality and financial strength, investors can rest assured that Costco has what it takes to pay growing dividends over the coming decades.

The article What's Fueling Costco Wholesale Corporation's Delightful Dividends? originally appeared on Fool.com.

Andrs Cardenal has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. 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.