2 Reasons Wal-Mart Stores, Inc. May Not Be a Top Dividend Stock

On Aug. 27, 1987, Wal-Mart paid its first cash dividend to shareholders. Since that date, a $1,000 investment in the company's stock -- based on its price alone -- is now worth $16,500.

That might sound impressive -- and it is --but to truly understand how important dividends are, look at what a shareholder who reinvested all the dividends between now and then would have.

No, your eyes aren't deceiving you. You are seeing the true power of dividends being reinvested and compounding year after year. While the stock's price appreciation turned $1,000 into $16,500, when you throw the dividends in to boot, the long-term shareholders have $22,550 sitting in their account. That's a huge difference.

Knowing that, and the fact that Wal-Mart is one of the world's largest employers, you might think that it is one of the top dividend stocks to buy today. I would argue, however, that this isn't the case. Let me explain why.

A shrinking chasm between the dividend and free cash flowThere's no metric more important for dividend investors to watch than free cash flow (FCF). This number represents the amount of money that a company has put in its pockets during the past twelve months, minus any capital expenditures.

At the end of the day, it is from FCF that dividends are paid. As you can see from the graph below, Wal-Mart's FCF has been shrinking, while the dividend has been growing, for the past couple of years.

Wal-Mart's FCF and Dividend |Create infographics

There are two crucial things to take from this. First of all, even though trends were not in the company's favor between 2010 and 2013, by the end of last year, Wal-Mart was still only using 61% of its FCF to pay its dividend -- a safe amount.

Second, shareholders will be quick to point out that the situation has largely reversed itself over the past twelve months. Indeed, FCF has grown by a whopping 34% over the past nine months, and only 45% of it has been used to pay the dividend.

Normally, I would say that this means Wal-Mart deserves to be a "top dividend stock to buy", but there are a few things holding me back. First and foremost is how Wal-Mart came by this huge increase in FCF. According to the company's SEC filings: "The increase in free cash flow was primarily due to the timing of payments for income taxes and capital expenditures."

In other words, this was not from an increase in cash produced by the business, just the timing of tax payments. If the company had paid the same amount in income taxes during the first nine months of this year as in previous years, then cash from operations would have only increased 3% in 2014 -- instead of 16%.

Losing market sharePerhaps the second most important metric for dividend investors in consumer goods companies is same store sales. This is important, because any company can increase revenue by simply building more stores. But it takes a special kind of store to consistently convince customers to buy more year in and year out.

When compared to Costco and Target , Wal-Mart simply hasn't been as impressive.

Same Store Sales Trends |Create infographics

But let's be crystal clear -- this doesn't necessarily make Wal-Mart a "bad" stock to own. It still has more than enough cash to pay its dividend, and the company could start growing same store sales at a brisker pace once again.

But this means that -- given sales and FCF trends -- the company is no longer a "top dividend stock to buy" right now.

The article 2 Reasons Wal-Mart Stores, Inc. May Not Be a Top Dividend Stock originally appeared on Fool.com.

Brian Stoffel 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.

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