Walgreen (WAG) is the largest retail pharmacy in the United States. The company operates nearly 8,000 stores and recorded revenue of $72 billion in 2011. Walgreen's main competitor is CVS Caremark (CVS).
Walgreen stock currently trades at $29.57 per share, off from a high of about $45 per share in 2011. The current yield is 3.72%. Let's take a look at the ten-year dividend history:
*Dividend increase already announced.
The dividend has grown at an astounding rate over the last decade, increasing by over a factor of five since 2004. This kind of dividend growth is highly desirable. I'll calculate the payout ratio as a percentage of the free cash flow in order to make sure the dividend is sustainable.
|Year||Free Cash Flow (Mil $)||Float (Mil Shares)||Payout Ratio|
The average payout ratio over the last three years is just 25.3%. This is extremely low and means that the dividend has plenty of room to grow.
I will use the Dividend Discount Model to put an estimated value on the company. This model assumes that the value of a company is purely the sum of all future dividends discounted back today. This is a reasonable valuation method if you are a dividend investor. The discount rate should be your required rate of return, and I will use a discount rate of 8%, which is roughly the long-term growth rate of the market as a whole.
Instead of assuming a future dividend growth rate and calculating a fair value estimate, it may be more reasonable in this case to do the opposite: calculate the future dividend growth rate which justifies the current stock price. I will assume that the dividend will grow at some rate for the next ten years, and then 3% after that, and my goal is to calculate that ten-year rate. With a current market price of $29.57 per share, this rate comes out to 8.14%. What this means is that if the dividend grows at a higher rate than 8.14% then the stock is currently undervalued.
With a yield of 3.72%, a historical dividend growth rate of over 20%, and a payout ratio of just 30%, Walgreen is significantly undervalued from a dividend point of view. As long as the dividend grows faster than about 8%, which appears to be a highly likely scenario, Walgreen at current prices is a bargain and would make a fantastic addition to a dividend-focused portfolio.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.