Since warehouse clubs made their debut, Costco has been a leader. In its first six years, sales went from zero to $3 billion – a first for any company.
Steady growth followed, and Costco now operates more than 750 stores in 11 countries.
With more than 245,000 employees, it is easy to assume that the organization keeps wages and benefits low to protect profits. However, Costco has done just the opposite, with great success.
Pay rates average $20.89 an hour, and employees frequently comment that their health benefits are affordable – a huge draw in a time when medical costs are rising much faster than salaries.
These points are great for keeping warehouses staffed, but investors aren’t always convinced whether Costco stock is worth buying for its dividend. Can Costco return value for shareholders without cutting these costs?
How Does Costco Make Money?
BJ’s Wholesale Club is the most obvious competitor when considering retailers in the same market niche.
All of these retailers achieve their lower prices through volume discounts with manufacturers, but Costco goes a step farther.
Costco [NASDAQ: COST] typically stocks a single brand or variety of each type of product, which means that sales for the specific item are much higher than in competing stores.
This allows Costco to negotiate lower prices than competitors can offer. For example, while a typical Walmart Supercenter offers approximately 140,000 products, there are just 4,000 options at Costco.
The only exception is when Costco’s house-brand Kirkland Signature offers a similar item. In those cases, shoppers can choose between Kirkland Signature and the national brand.
Costco [NASDAQ: COST] relies on membership fees for most of its operating income, and generally, warehouses run with the barest minimum of amenities. For example, products are displayed on the same pallets used to deliver them, eliminating the resources required to stock shelves.
The company doesn’t bother with advertising, and it has implemented a variety of other cost-saving measures. For example, it reduces energy-consumption by relying on natural light whenever possible, and it doesn’t stock grocery bags for shoppers to carry items home.
All of these efforts have combined to create a company that can easily weather economic ups and downs.
In fact, Costco [NASDAQ: COST] beat the S&P 500 in 2018, and revenue, operating income, and earnings per share have been increasing steadily for the past ten years.
But will Costco continue to grow? And will investors see any of those profits from share price gains or Costco dividend income?
Is Costco Special Dividend Worth It?
Investors interested in buying Costco [NASDAQ: COST] should consider the company’s dividend history – and the opportunities that shareholders may have in coming months and years.
At first glance, it might seem that the 0.9% dividend yield is nothing to be excited about.
However, since December 2012, Costco has paid its shareholders three special dividends: $7 in 2012, $5 in 2015, and $7 in 2017.
Based on business patterns and current financials, some analysts believe another will be announced in 2019.
The first hint is that the three special dividends were paid an average of 2.25 years apart, which could indicate that the next will occur in the second half of 2019. Perhaps more telling, during the first quarter earnings call, CFO Richard Galanti didn’t rule the possibility out.
Other promising indicators include the fact that Costco’s dividends could increase, because the current payout ratio is a low 30%. Compare this to Walmart’s 62.04%.
The payout ratio is a calculation of the company’s annual dividends paid as a percentage of earnings (dividends per share divided by earnings per share), so Costco [NASDAQ: COST] has plenty of room to increase dividends without putting cash flow at risk.
Though Costco’s payout ratio is low, the fact is that based on earnings, there may be no need to increase the payout ratio to increase dividends.
Earnings have been going up steadily, thanks to growth in revenues and continued focus on economies of scale. As of August 2018, the trailing 12-month earnings per share figure went up by nine percent year-over-year.
Finally, despite some recent anomalies, as a general rule, Costco has increased its dividend each year.
Last quarter notwithstanding, the average increase has been 13.1% per year over the past five years. These are all signs that income investors can find a lot to like with Costco.
Is Costco a Buy?
At the end of 2018, Costco stock prices dropped precipitously.
Most analysts chalked this up to unexpectedly high operating costs, which were driven by higher wages, improved rewards for Costco’s branded Citi/Visa card, and increased merchandise costs.
However, investors that chose to sell apparently missed the good news in Costco’s financial reports.
Same store sales increased by 7.5% – far higher than the figures reported by competitors – and e-commerce saw a year-over-year improvement of 26.2%.
More importantly, membership numbers continued on their upward trajectory. This is critical to the company’s underlying health, as Costco’s profits are ultimately driven by membership fees. Instead of looking at the sell-off as a bad sign, new investors may want to buy now, before shares return to premium-level pricing.