From the people who brought you Manly Stock Wars, we're clearing the arena again for another epic battle. What in the world am I talking about? It's simple.
In honor of the holiday shopping season - which is a make-or-break time for many retail companies - we've decided to pit eight dividend payers in the sector against each other in a single elimination tournament. We're throwing in a twist, too.
As I revealed at the end of September to Wall Street Daily readers, our country is facing a stark economic reality: Wealthier people feel more confident than poorer people do right now. And it's manifesting itself in their spending habits.
Therefore, to really identify the best dividend opportunities in the retail sector, we're pitting higher-end retailers against their lower-end counterparts in an effort to determine who really stands to win out this holiday season - the haves or the have-nots.
Here's a breakdown of our competitors:
Before we get to the first matchup, let's quickly review our rules of engagement.
Only the Strong Survive
The concept of a stock war couldn't be simpler.
We pit two similar companies against one another and conduct a blow-by-blow fundamental comparison to determine the most investment-worthy one. Specifically, we use our seven guiding principles of dividend investing, plus one more critical fundamental (valuation).
Armed with the analysis, you can then consider buying the winner - or both, if it's a close matchup.
Since we have eight potential winners in this special series, we recommend waiting until the final matchup is over before taking any action.
~Round 1: Simple Business
A wise man once told me, if you can't explain the investment case to a five year old, you don't know what you're talking about. Fortunately for us, retail is a pretty straightforward industry. That is, as long as companies don't try to sell a little of everything to everyone. Thankfully, that's not a concern here.
Nordstrom sells designer and luxury attire and accessories, whereas Kohl's sells non-specialty clothing and accessories. Simple enough.
~Round 2: Steady Demand
As I alluded to earlier, the retail sector is notoriously seasonal. Accordingly, we should expect a certain degree of volatility in both companies' sales levels. That said, the income inequality between the haves and have-nots right now is larger than ever, which means Nordstrom is likely to enjoy (relatively) steadier demand.
~Round 3: Cash Flow Positive
When a company spins off a ton of cash, it can easily afford to keep paying its dividend, which is what matters most to us. Over the past year, both companies generated enough free cash flow to cover roughly two and a half years' worth of dividend payments.
~Round 4: High Cash Balance
Cash is still (and always will be) king. Typically, we insist on at least enough cash to cover two quarters' worth of dividends. Both companies easily meet that minimum. Kohl's has enough cash stockpiled to pay for more than seven quarters' worth of dividends. But Nordstrom is more flush, with enough dry powder to pay 16 quarters' worth of dividends.
~Round 5: Minimal Need for Credit
The more debt a company carries, the less money that's left over to pay dividends - especially during a rising interest rate environment. So where do Kohl's and Nordstrom's debt levels check in?
Well, the median debt-to-equity (D/E) ratio for the industry is 0.42. And neither comes close to that. Kohl's D/E ratio checks in at 0.82, while Nordstrom's is even higher at 1.57.
Despite the higher-than-average levels, neither company is in much danger of defaulting on its loans, thanks to strong cash flow generation. Nevertheless, one is clearly the safer option.
~Round 6: Earnings Buffer
Just like the high cash balances we sought in Round 4, earnings can provide a buffer to protect against companies cutting (or eliminating) dividends. One of the best metrics to track this cushion is by calculating a company's dividend payout ratio (DPR). As you'll recall, I generally only recommend investing in companies with DPRs of less than 80%.
Kohl's clocks in with a trailing 12-month DPR of 32.26% - well within our guidelines for dividend investing. However, Nordstrom is again the safer bet, with a DPR of 28.99%.
~Round 7: Dividend Yield and Growth
It shouldn't come as a surprise that a solid yield and strong dividend growth top the list as two of the most important fundamentals for us.
On the yield front, Kohl's wins out at 2.6% versus 1.9% for Nordstrom.
But we value dividend growth much more, which makes Nordstrom the ultimate winner of this round. The company has paid and increased its dividend for four years running, including an 11.1% hike in the last year.
Kohl's only started paying a dividend in 2011. And its dividend hike in the last year checked in at a slightly lower 9.4%.
~Round 8: Valuation
If I've said it once, I've said it a thousand times …
The only way to really win in the market is to buy low and sell high. That's especially true for income investing. Paying an arm and a leg to get a finger is never a good idea.
Again, there's a clear winner here.
Nordstrom has a price-to-earnings (PE) ratio of 16.87, which translates to a 6.7% discount to the average stock in the S&P 500 Index. On a forward PE ratio basis, it's trading at almost a 5% discount to the S&P 500.
Meanwhile, Kohl's trades at a PE ratio of 12.96 and a forward PE ratio of 12.12. Both represent 20%-plus discounts to the average stock in the S&P 500.
And the Winner Is …
After eight rounds of tough, head-to-head combat, let's see how the scorecard looks:
Not a shutout, but certainly a dominating performance by Nordstrom.
With steadier demand in a still-recovering economy, larger cash balances, a more comfortable earnings buffer, and a more solid, consistent history of growing its dividend payments, Nordstrom emerges as the victor of our first Dividend Class Warfare matchup.
I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Dividends & Income Daily is a team of financial researchers. This article was written by Louis Basenese, one of our financial researchers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.