Dividend growth investing is lots of fun, especially if you have a systematic methodology to determining which companies' dividends are safe and which ones' aren't. That is why we created a forward-looking assessment of dividend safety in our innovative, predictive dividend-cut indicator, the Valuentum Dividend Cushion™. In this article, let's evaluate the investment merits of Whole Foods (WFM), as well as its dividend under this unique but yet very straightforward framework.
Return on Invested Capital
Click to enlarge images.
Whole Foods' Dividend
Whole Foods' dividend yield is currently well below average, offering just below a 1% annual payout at recent price levels. But hold your horses, and don't turn us off just yet. What is really compelling is the level of yields at the grocers (mid-single digits), and the dividend growth potential that Whole Foods currently has. And even though grocers such as SuperValu (SVU) and Roundy's (RNDY) have cut their dividends recently, Whole Foods is in a vastly different place. As a relevant and very important note, to learn how to shield your portfolio from these dividend growth blowups, please click here.
For starters, we think the safety of Whole Foods' dividend is excellent (please see our definitions at the bottom of this article). We measure the safety of the dividend in a unique but very straightforward fashion. As many know, earnings can fluctuate in any given year, so using the payout ratio in any given year has some limitations. Plus, companies can often encounter unforeseen charges, which makes earnings an even less-than-predictable measure of the safety of the dividend in any given year. We know that companies won't cut the dividend just because earnings have declined or they had a restructuring charge that put them in the red for the quarter (year). As such, we think that assessing the cash flows of a business allows us to determine whether it has the capacity to continue paying these cash outlays well into the future.
That has led us to develop the forward-looking Valuentum Dividend Cushion™. Please click here to learn more about this helpful tool for the financial advisor. The measure is a ratio that sums the existing cash a company has on hand plus its expected future free cash flows over the next five years and divides that sum by future expected dividends over the same time period. Basically, if the score is above 1, the company has the capacity to pay out its expected future dividends. As income investors, however, we'd like to see a score much larger than 1 for a couple of reasons: one, the higher the ratio, the more "cushion" the company has against unexpected earnings shortfalls, and two, the higher the ratio, the greater capacity a dividend-payer has in boosting the dividend in the future. For Whole Foods, this score is 6.1, revealing that on its current path the firm can cover its future dividends with net cash on hand and future free cash flow. The firm's score is remarkable compared to its grocery peers and dividend-payers in general.
Now on to the potential growth of Whole Foods dividend. As we mentioned above, we think the larger the "cushion" the larger capacity it has to raise the dividend. However, such dividend growth analysis is not complete until after considering management's willingness to increase the dividend. As such, we evaluate the company's historical dividend track record. If there have been no dividend cuts in 10 years, the company has a nice growth rate, and a nice dividend cushion, its future potential dividend growth would be excellent, which is the case for Whole Foods. The firm simply has an excellent cash-flow profile.
And because capital preservation is also an important consideration, we assess the risk associated with the potential for capital loss (offering investors a complete picture). In Whole Foods case, we currently think the shares are fairly valued, so the risk of capital loss medium. If we thought the shares were undervalued, the risk of capital loss would be low.
All things considered, we like the potential growth and safety of Whole Foods' dividend, but the yield is still a bit low. We'd wait for a dividend increase or a pullback in the shares to consider it in our income portfolio. And we wouldn't rule out Whole Foods from being one of the best dividend growth stocks in the grocery space.