Costco (COST) increases dividend by 11%, but trades at a frothy valuation

Costco’s (NYSE:COST) dividend was increased by 11%.  Its overall yield is 1.15%. The firm started paying a dividend in 2004.

Costco Wholesale operates retail stores that primarily earn money from memberships. It firm operates over 500 membership warehouse clubs in the U.S.  It also maintains operations of nearly 100 stores in Canada.  The firm has also expanded into Mexico with 36 stores, and also 28 stores in the U.K., and 25 in Japan.  It also has operations in Spain, Australia, and Korea.  The firm is the third largest retailers in the United States. The firm was founded in 1976 and is located in Issaquah, Washington.

Costco has maintained a three-year growth rate of dividends of 12.4 percent. Costco currently ranks 4th in dividend yield within the large cap services, discount, variety store category. The quarterly dividend for the May payment will be $0.50 versus the prior year rate of $0.45 per share. Costco is not a member of our Top 100 Dividend Stocks.  (see below).

The dividend will be paid at the new higher rate on May 26, 2017, to shareholders of record at close of business on May 12, 2017. Costco Wholesale Corp. is currently priced at $171.64. Listed in the table below are the quarterly dividend payments since 2010.

Date Quarterly Dividend
5/12/2017 0.5
2/8/2017 0.45
11/2/2016 0.45
8/10/2016 0.45
4/27/2016 0.45
2/10/2016 0.4
11/10/2015 0.4
8/12/2015 0.4
4/29/2015 0.4
2/11/2015 0.355
2/5/2015 5
11/12/2014 0.355
7/9/2014 0.355
5/14/2014 0.355
2/12/2014 0.31
11/13/2013 0.31
8/7/2013 0.31
5/15/2013 0.31
2/6/2013 0.275
12/6/2012 7
11/14/2012 0.275
8/8/2012 0.275
5/23/2012 0.275
2/8/2012 0.24
11/8/2011 0.24
8/3/2011 0.24
5/11/2011 0.24
2/9/2011 0.205
10/27/2010 0.205
8/4/2010 0.205
5/5/2010 0.205
2/10/2010 0.18

Analysis of Costco is based upon our five key criteria for the Top 100 list, which include;

Category Value Score
Dividend Yield 1.15% 501
Dividend Growth (3-7 year avg) 13 236
Forward P/E 29.1 487
S&P Financial Rating A+ 152
Beta 0.75 82
Total Score 1,458
% Yield 3 Year Div. Growth Rate 7 Year Div. Growth Rate SPS 2017 P/S Ratio 10 yr P/S Low 10 yr P/S High 5 yr low Yield % 5 yr max Yield %
1.15% 12.4 13.7 289.95 0.61 0.32 0.70 0.93% 1.40%

Positives;

  • Costco maintains an investment grade rating of A+.
  • Costco’s current dividend yield (1.15%) is at its five-year average historical dividend yield.
  • Costco maintains a beta of 0.75, lower than the average company.
  • Costco has paid out a dividend consecutively for the past 13 years.

Negatives;

  • Costco’s dividend yield is below that of the S&P 500 Index.
  • Costco is trading above its ten-year average price/sales (P/S) ratio.

Latest Earnings & Overall Analysis:

Costco issued its earnings data on March 2nd. The company reported $1.17 EPS for the quarter, missing the consensus estimate by 18 cents.  Costco reported lower-than-expected quarterly comparable-store sales as well.  The firm’s same-store sales climbed by a mere 3 percent in the second quarter.  This was slightly below estimates of  3.2 percent growth.  Costco indicated it would raise annual fees $5 to $60 for Goldstar and business members.  For executive members, annual fees would climb to $120, up ten dollars.  The fee increases will affect about 35 million members.  Nearly half of those members are the more profitable executive type.

Membership fees are an immense portion of Costco’s operating income in 2016, accounting for nearly two-thirds of profits. Total net income for the retail giant dropped to $515 million from $546 million the year earlier. The firm earned $1.24 per share last year.  These results were well below analyst expectations of $29.86 billion in revenue for Q2.

One critical advantage for Costco over other firms within the industry is average mark-up.  Costco maintains very low prices as its base price is only stepped up by about half of that of other major firms. The firm can afford to do this as its primary focus is on membership fees. The firm has a very loyal customer base and maintains a very fast turnover ratio, or goods moving through the store.   The company large warehouses, despite their immense size, generate over $1000 in SPSF, or sales per square foot.

Over 90 million customers go through Costco’s doors each year.  Retention rates are enviable, at over 90 percent per year.  The firm is no doubt one of the premier brands within the retail space.  The firm’s stock is also less volatile, with a beta well below 1. The firm maintains an A plus credit rating from Standard & Poor’s as well. The firm’s consistent growth is to be admired.  The firm has raised its dividend by 13 percent in the last five years. However, its payout ratio is still low, at 34 percent for the coming year.

2016 2015 2014 2013 2012
Earnings per Share 5.33 5.27 4.65 4.49 3.97
Annual Dividend 1.7 1.51 1.33 1.17 1.03
Payout Ratio 31.89% 28.65% 28.60% 26.06% 25.94%
We expect the firm to earn about $5.75 a share next year as the membership rate increases kick in along with improved sales growth due to a higher focus on groceries. Priced at $171.64, the firm is trading at 29 times next year’s earnings.  This is far above the average stock within the S&P 500 index. This high valuation along with a low payout ratio causes Costco to only pay its investors a yield just above one percent. Although the company is no doubt a solid firm to own, its low yield and upscale valuation push the firm’s stock well out of our Top 100 list.
Earnings per Share 2017 (projected) $5.75
Dividend $1.95
Payout Ratio 34.51%

Based on the firm’s low dividend yield, low payout ratio, and elevated price/earnings & price/sales ratios, Costco Wholesale Corp. does not qualify as one of our Top 100 Dividend Stocks

Costco Wholesale Corp. Dividend Yield Chart (Click to enlarge)

Chart Explanation:  Dividend growth stocks may be viewed undervalued when the current yield is above historical readings for the past 5 years.

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