It's tempting for investors looking for income to give in to the appeal of high dividend yields. But seasoned income investors know that yield is only one facet of the equation when building a portfolio of good dividend stocks for long-term income generation. Indeed, stocks with unimpressive dividend yields often possess some of the best long-term value for income investors. Whole Foods and Costco are two of these dividend stocks that could easily be looked over.
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There are a number of reasons for investors to be interested in Whole Foods as a dividend stock. First and foremost, the combination of a low payout ratio of 35%, recent dividend growth, and plans for continued business growth is a recipe for sustained dividend growth.
Image source: Whole Foods.
Second, and perhaps even more important, the stock itself appears to be undervalued. Despite an aggressive plan to continue growing sales over the long haul, Whole Foods trades at a reasonable multiple to earnings of about 20.9 -- not bad in light of management's plans to more than triple store count in the U.S. and continue expanding internationally.
Finally, the company is disciplined in capital allocation, simultaneously balancing meaningful growth, a share repurchase program, and dividends.
Costco's dividend yield of just 1% may be laughable to some dividend investors. But, like Whole Foods, its dividend is poised for long-term growth, thanks to a conservative payout ratio of 28% and the company's consistent growth in earnings.
With a $72 billion market capitalization, Costco may already be a very large company. But size certainly hasn't held it back from growing EPS. Over the last three years, Costco's earnings per share have increased at an average rate of 11.4%. And, going forward, there's no reason to expect the EPS growth rate to slow. With EPS climbing this meaningfully, Costco's dividend has plenty of room for further increases down the road.
One of the reasons both Whole Foods' and Costco's boards have maintained a low payout ratio is because they believe there is significant room left for business growth. As long as the companies feel strongly about growth potential, dividend payouts will likely remain suppressed. But where Whole Foods and Costco lack in dividend yield, they make up for in fundamentally enduring business models and dividend growth potential.
Whole Foods and Costco offer dividend investors an opportunity to tap into growing income streams while also buying excellence.
The article 2 Small Dividend Yields With Big Growth Potential originally appeared on Fool.com.
John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Daniel Sparks has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Costco Wholesale and Whole Foods Market. 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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