Costco Wholesale Corporation Hikes Its Dividend: Why This Is Important

By Markets Fool.com

Source: The Motley Fool

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Costco recently announced a 13% dividend increase, hiking quarterly payments from $0.355 to $0.40 per share. Management also got authorization for a new $4 billion stock buyback program.

Thus, it looks like Costco is increasingly rewarding investors with growing cash distributions. Let's take a look at why this is a major return driver for investors in Costco stock.

Growing dividends from Costco
Costco started paying regular dividends in 2004. What began as a quarterly payment of $0.10 back then has now multiplied by four. In spite of this impressive growth over the last ten years, the dividend yield is still quite modest, at 1.1% based on Costco's current stock price.

However, Costco is also quite fond of special dividends, and investors should not overlook this fact. On Jan. 30, the company announced a special dividend of $5 per share, payable on Feb. 27 to shareholders of record as of Feb. 9. This special dividend represented a generous dividend yield of 3.4% based on the stock price at the time.

This was not the first time Costco paid a special dividend. In November 2012, the company distributed a $7 per share special dividend in anticipation of an increase in dividend taxes. Costco stock was trading in the neighborhood of $104 back them, so this provided a big return of 6.7% at the time.

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Costco's regular dividend yield is not particularly high, but the company has consistently increased its regular dividend at a generous rate over the last decade. Besides, Costco's big special dividends have provided an additional source of income for Costco shareholders. Importantly, the company looks well positioned to continue delivering solid dividend growth in the years ahead.

Moving forward
Most discount retailers charge relatively small markups, so they need to generate high sales volume to drive earnings and cash flow. Following this pattern, Costco charges aggressively low prices for its products, which is a big advantage from a competitive perspective.

However, Costco differs from its peers in that it makes most of its profit from membership fees. This means the business generates more predictable and dependable cash flow over time.

Costco's free cash flow can vary from year to year depending on capital expenditures, mostly to finance store base expansion. But Costco has an extraordinary track record of consistency when it comes to long-term operating cash flow growth. This means the business generates tons of cold hard cash, and management then gets to decide how much of that money it wants to reinvest for growth and how much it wants to distribute to investors via dividends and buybacks.

COST Cash from Operations (TTM) Chart

COST Cash from Operations (TTM) data by YCharts

Importantly, Costco has more than enough financial strength to continue raising its dividend for years. The company has a pristine balance sheet with a net cash position, meaning that Costco has more cash and liquid investments than debt on its balance sheet.

Costco brought in nearly $2.03 billion in operating cash flow during the last two quarters. Capital expenditures absorbed $1.17 billion of that money, leaving approximately $867 in free cash flow for that period. Regular dividends amounted to only $156 million, or 18% of free cash flow, so Costco has considerable flexibility to continue increasing its quarterly dividend based on current cash flow.

Also, the business is remarkably well positioned to grow cash flow over time. Costco announced a healthy increase in comparable sales (excluding foreign exchange and fuel price fluctuations) of 7% for the 31-week period ended in March, so demand looks quite healthy.

The company ended the last quarter with 671 locations globally, and management intends to open 20 additional stores over the coming two quarters. International markets are performing better than expected, so management is particularly encouraged by growth opportunities overseas. According to Costco's management, the possibility of reaching 1,000 locations is "certainly not out of the realm."

Costco has an online presence in four countries: the U.S., Canada, U.K., and Mexico. The company reported a big increase of 23% in online sales last quarter, so chances are that the online segment will be a vibrant growth driver in the years ahead as Costco consolidates its global online presence.

What dividend growth means for investors in Costco stock
Dividends don't only provide income, growing dividends send a powerful signal regarding the health of the business. You need a solid company producing consistently growing cash flow to sustain dividend growth, so investing in dividend growth stocks is one of the most proven strategies to beat the market.

Based on data from Goldman Sachs, a $10,000 investment in non-dividend paying stocks in 1972 would have grown to $30,363 by the end of 2014. Companies with consistent dividend growth did much better than that, since the same amount of money invested in dividend growers would have turned into a much bigger $630,024 over that period.

Dividend growth investing can do wonders for your portfolio, and Costco has what it takes to continue delivering growing dividends over the long term. These growing cash distributions are a major plus for investors in Costco stock.

The article Costco Wholesale Corporation Hikes Its Dividend: Why This Is Important originally appeared on Fool.com.

Andrs Cardenal has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale and Goldman Sachs. 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.