Since 2008, Wal-Mart (WMT) has managed to grow earnings from $3.42 to an estimated $4.45 by the end of 2011. That’s pretty impressive relative to the fact that the price of the stock has been dogged in the lower fifties for much of the past few years—you could have bought shares of Wal-Mart for $53 each in both 2008 and 2011, yet earnings have grown 30.11% over that time frame, or 10.03% annually. As long-term investors, we seek ownership of the largest risk-adjusted future earnings possible, and shares of Wal-Mart represent significantly more value now than they did three years ago.
Likewise, Wal-Mart has been raising its dividend at a very outsized rate in recent years. Since 2001, the declared annual dividend has risen from $0.27 annually to an estimated $1.46 by year's end. Over the past ten years, Wal-Mart has grown its dividend by 18% annually, which is a very, very impressive rate.
Of course, potential investors shouldn’t expect such prolific dividend increases over the coming decade. There are two primary reasons why Wal-Mart investors shouldn’t be expecting this trend to continue over the coming ten years. First of all, Wal-Mart grew earnings by 12.0% over the past decade as it saturated the American market and expanded internationally. I think a conservatively realistic projection of 7-8% annual earnings growth is what future investors in Wal-Mart should anticipate going forward.
And secondly, we have seen an increase in Wal-Mart’s payout ratio. For instance, in 2003, Wal-Mart paid out $0.35 in annual dividends relative to $2.03 in annual earnings. That’s a very paltry payout ratio for a mega-cap company like Wal-Mart; it’s hardly above 17.2%. But, since Wal-Mart has been raising its dividend 18% annually relative to 12% earnings growth, we have seen an increase in the payout ratio as Wal-Mart’s dividends relative to total earnings have grown. Most likely, Wal-Mart will pay out $1.46 per share in annual dividends this year, relative to around $4.45 in earnings. That’s a payout ratio of 32.8%. That’s still a very small overall dividend payout ratio, but it is about double what it was a decade ago.
I think that Wal-Mart will raise its dividend by 10-11% over the coming five years. Management has expressed its willingness to eventually raise Wal-Mart’s payout ratio to 60-65% of earnings, and Wal-Mart ought to experience high single digit earnings growth in the coming years, which is a good combination of headwinds for Wal-Mart shareholders.
For me, I’m drawn to companies that have dividend yields over 3% that have the infrastructure in place to raise dividends by 10% annually for the foreseeable future. Granted, Wal-Mart shares have been rallying lately, so you would have to wait for shares to come down below $50 to lock-in that 3% yield (Wal-Mart last traded below $50 per share in August). Given that Wal-Mart has been raising its dividend by 18% for the past decade and is still only paying out 30% of earnings as dividends, coupled with the fact that Wal-Mart is poised to experience high single digit earnings growth, it ought to indicate that investors have a very highly realistic chance of experiencing double digit dividend increases in the future.
Let’s say that Wal-Mart is able to grow earnings by 8% over the next decade. That would give Wal-Mart earnings per share of $9.61 ten years from now. Although management expressed a desire to increase the payout ratio to 60-65%, let’s tentatively assume that Wal-Mart will be paying out half its earnings as dividends to investors a decade from now. That would mean that Wal-Mart would be paying out about $4.80 in annual dividends at that point.
If you could purchase shares of Wal-Mart at $50 (they’ve rallied up $3 this week to $55, so you might have to be patient for a bit), that would give you an annual dividend yield of 9.6% ten years from now, relative to your initial investment.
These are some of the reasons why I think it would be a good idea for retirement investors to consider adding shares of Wal-Mart to their retirement account. There’s only a handful of blue-chips that regularly raise their dividends by 10% or more annually, and there’s even fewer blue-chips that have as low of a current payout ratio as Wal-Mart does. These are good headwinds for investors looking to generate growing streams of income in tax-advantaged accounts.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.