Agreeing To Buy Wal-Mart With A Higher Yield

| About: Wal-Mart Stores, (WMT)

Summary

Wal-Mart recently announced a 2% dividend increase.

The new yield is on the higher end of what has been historically available with the security.

Yet you could get paid to agree to an even higher yield.

One of the great things about Wal-Mart's (NYSE:WMT) dividend policy is that it doesn't mess around with quarterly announcements. Instead, the mega-retailer chooses to announce an entire year's worth of payments upfront. This year was no exception, detailing a $2 annual dividend to go along with the four payment dates. You don't often see that sort of payout commitment, but Wal-Mart has been a leader in this area.

Of course one of the not so great things about Wal-Mart's dividend policy has been the rate of increases as of late. It may seem a bit unappreciative - after all it is a payout raise and not a freeze, cut or suspension. Yet investors had become accustomed to much larger figures.

Back in fiscal year 2010 Wal-Mart paid a $1.09 annual dividend. This was subsequently increased by 11%, 21%, 9% and 18% in the next four years to reach an annual mark of $1.88. Yet from that point, the growth rate has slowed dramatically.

The $0.47 quarterly dividend paid in 2013, turned into $0.48 in 2014, $0.49 in 2015 and now sits at $0.50 for 2016. (Note that the fiscal year is always a year ahead for Wal-Mart.) So after spectacular growth that some got accustomed to, we've now seen "just" penny per quarter increases during the last three years. This year's boost marks a 2% year-over-year increase on a per share basis, and even less on a company-wide basis due to share repurchases.

Incidentally, this could be a prudent course of action. Wal-Mart has its share of short-term concerns and is in the process of improving the business. Further, the company recently reiterated its expectation that it will make less money in the coming year. While Wal-Mart has the capacity to increase its dividend at a faster rate, the lesser increase allows for more funds to be "flexible" - either for use in bettering the business or repurchasing shares at now lower prices.

As I write this, shares are trading around $62.50 or so. Based on the known $2 dividend payment, that equates to an annualized yield of 3.2%. Aside from when shares briefly went below $57 last year, this represents the highest dividend yield for the company that I could find in the last two decades. For a long time the average mark was well below 3% and even 2%. Only recently has the 3% yield mark become the "norm." (Although to be complete, the payout ratio is now higher as well.)

Now assuredly there are short-term concerns. Yet if you believe the long-term prospects of the business remain intact, it's times like these that tend to offer opportunity. When you start with an above average dividend yield, it doesn't take spectacular performance to turn in reasonable investing results.

I'll give you a "for instance." If you suspect that Wal-Mart could earn say $5 per share in five years (less than it did in the two previous years) and trade at a 14 multiple, this could equate to a 5.2% annual gain. The business doesn't have to perform better than it did previously, it just needs to regain its footing for an investment to work out.

Of course you might still be skeptical - in one of two ways. If you don't believe in the long-term economics of the business you likely would not be interested in partnering with Wal-Mart at any price. However, if you are interested it simply becomes a matter of, "at what price?"

Let's work with an illustration. If you're not interested in Wal-Mart at $62.50 with a 3.2% yield, perhaps $57 with a 3.5% yield sounds more interesting. For that matter, perchance you'd only be happy to own shares at $50 with a 4% yield. The key is to first figure out a price (if at all) that you'd be happy to partner with the company.

From there you have a couple of options. You could sit and wait, hoping that this price eventually comes about. Or you could make an agreement to buy at a lower price and express this interest (getting paid to do so). Let's explore this second option.

As I write this the bid for the January 2017 put option with a $57.50 strike price sits at $3.15. Let's call it $3 even to account for transaction costs and fluctuations. This means that if you agreed to set aside $5,750 to potentially buy 100 shares of Wal-Mart you would receive ~$300 upfront.

Now let's look at two basic outcomes: either the option is exercised or it is not. If the option were exercised your cost basis would be roughly $54.50 or so. Based on the current dividend, this represents a 3.7% starting yield and a nearly 13% discount to today's price. If you were willing to buy shares at $63 or $57 and hold for the long-term, clearly this situation could be favorable.

The second possibility is that the option is not exercised. In this case you keep your upfront premium and the cash you set aside to secure the agreement. You'd start with $5,750 and end with ~$6,050. This represents a 5.2% return in less than a year.

The risk here is that you may never own shares. Should shares of Wal-Mart go to $70 or $80, you'd be "stuck" with your 5% return and left to watch "what could have been." This is why it's important to be content with either side of the agreement. If you compare the return to idle cash, 5% is terrific at the moment. If you compare it to opportunity cost, it could be a bit harder to take. The agreement should fit your underlying investment goals.

Of course you're not limited to agreeing to buy at one price. If you instead agreed to buy shares at $62.50 you could have an 8% cash flow yield or else own shares around $57. Or if you agreed to buy at $50, your cash flow yield decreases below 3% but should be the option be exercised your return and cost basis look even better.

The point is that you're not stuck with two alternatives: buying or waiting to buy. There's a third possibility out there. Although Wal-Mart is presently trading with a dividend yield near its high, you can get paid to make an agreement to buy with an even higher yield. Like anything in the investing world, risks are present, but the concept is to figure out your goal and work from there.

Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.