Lowe's (NYSE:LOW) should be familiar to most Americans, at least to those Americans who own their own house and have ever refurbished. The company has been around for a long time and has a very impressive long-term track record of paying their loyal shareholders an increasing amount of money every year.
The company is currently favourably priced for investors looking to grow their dividend income in a sustainable and substantial way over the foreseeable future.
Over the last five years investors have gotten a price return of about 138%, or 18.9% on average per year. If you add in the slightly less than 2% dividend yield, investors have gotten total returns comfortably above 20% per year. That has to be considered pretty solid considering that this company was pretty large and well-known five years ago. It's not exactly a hot tech start-up.
Historical Dividend Growth
Lowe's has paid a quarterly cash dividend ever since the company was listed in 1961. More importantly, the dividend has been increased for decades and it has been consistently increased every May/June since 2004. Before that it was increased every now and then and sometimes at other times of the year. In short, this company likes to build their investors' income stream!
Between May 2013 and May 2018 - its latest increase - the dividend went from $0.18 to $0.48 per share per quarter. That's a whopping 167% increase over five years! On an average annual basis that translates to 21.7%. Incidentally, this growth rate is slightly higher than the growth rate of the stock price, lending credence to the notion that earnings growth and dividend growth are driving stock returns over time. Such a growth rate will increase investors' yield on cost rapidly. If you had bought at a yield of 1.8% five years ago, your current yield on cost would be a very respectable 4.8% - and growing.
As we have already seen, the dividend has increased at a very respectable rate over the last five years and at very predictable intervals. What is somewhat more concerning, however, is the payout ratio, which has increased from about 30% five years ago to a current 63%. One should note that the rapid increase lately is due to one-off charges, which means the underlying payout ratio is likely much closer to the 40% level.
At any rate, the payout ratio should be watched going forward. So far it is not a concern for me, as even the temporary high payout ratio is still below two-thirds of earnings, leaving lots of money retained in the business for growth investments.
Coming Dividend Hike
The Board of Lowe's seems to have settled on announcing the new and higher dividend for the year at the very end of May or the beginning of June each year. The same should be expected this year.
Last year the dividend was bumped by 17% to $0.48 from $0.41, almost exactly the same percentage-wise increase as the year before. Back in 2016 it offered a massive hike of 25%. We can therefore see a trend of a slightly decreasing growth rate over the years, which is not surprising given the high growth level the company comes from. I would therefore say that it is very unlikely that the growth rate this year will be higher than 17%. It would take a truly stellar year for that to happen.
In its latest earnings release, we can see that adjusted earnings per share are up 8.1% from last year. Reading a bit further down, we can see that management guides for an EPS this current fiscal year of $6.00 to $6.10. If we look at fiscal year 2018, which is a year not severely impacted by one-off charges, the company earned $4.09 per share. This number is also the highest EPS number the company has ever had. If the company reaches even the low end of guidance for this fiscal year, earnings will grow a massive 47% from the previous all-time-high level.
If the Board announced a 16.7% dividend hike, the new annual dividend would be $2.24 - representing a payout ratio of 37.3% of earnings of $6.00. A slightly lower hike of almost 15% to an annual dividend level of $2.20 would entail a payout ratio of 36.7%. As we can see, the payout ratio will not vary much between these two scenarios, which is an argument for the higher increase of the two.
There is an argument to be made for an even higher increase given how well the company is expected to perform, but when we look at the history of the payout ratio, I think the Board would like to keep it below the 40% threshold. My prediction is therefore for an increase of slightly below 17% for a new quarterly dividend of $0.56.
An obvious risk factor for Lowe's is the state of the economy. From its all-time-high level before the housing bubble popped and until the bottom was reached, the stock was down approximately 50%. So a recession with a resulting severe slowdown in the housing market will also impact the home improvement market and negatively impact Lowe's revenues. Another risk is competition, though in this case it is less of a risk than usual. There is only one true national competitor, Home Depot (NYSE:HD). Other competitors are smaller, local ones. These might know the local market better, but will have less pricing power with suppliers. Currencies is a risk in that a portion of the goods it sells are imports. So a falling U.S. dollar will make imports more expensive, hurting margins. Tariffs are another risk that has come to the fore lately. Higher import prices will hurt margins insofar as it can not raise prices to its customers.
So how much does Mr. Market say we have to pay for this consistent dividend grower that is expected to increase its earnings substantially this year? As it turns out, it's actually not that expensive. Below I have compared Lowe's on some key metrics with two competitors. One competitor, Home Depot, is obvious. But as I've said, there are no other pure peers at the national level. As the third company I've therefore chosen Walmart (NYSE:WMT) as they are the largest physical retailer and because they sell a wide variety of goods, many of which are overlapping with those of Lowe's.
Lowe's Price/Sales ratio falls right in the middle of the ratios of Home Depot and Walmart. As for Price/Earnings, Walmart is by far the most expensive one with a ratio of 44.4x. Home Depot and Lowe's are priced quite similarly at 19.4x and 20.7x, respectively. Again, Lowe's comes in second place. When it comes to the dividend yield, Lowe's is the most expensive one. Part of the reason is, as we have seen above, the low payout ratio. Nonetheless, the other two will offer investors higher current income.
Walmart seems a bit on the expensive side but the two pure home improvement companies look quite attractive here. Paying around 20x earnings for companies with a solid position, healthy growth and strong fundamentals is not at all too much. Investors should keep in mind that Lowe's dividend yield will soon increase noticeably. If the dividend is increased in line with my prediction, it will soon reach 2.1%.
Analysts on Wall Street expect Lowe's to be able to clock in a long term annual earnings per share growth rate of 16%. Add in the current dividend yield of 1.8% and investors can expect total shareholder returns of 17.8% annually over the next five years. This is slightly below what it has achieved over the last five years, but such a streak is hard to match. Expected returns almost twice what the market as a whole delivers over time is truly solid. Dividend growth investors should add Lowe's to their portfolios.
Lowe's has paid a quarterly dividend ever since it went public in 1961. Since then, the company has grown quickly and steadily and the dividend has grown with it. In recent years the dividend has increased by more than 20% per year. Though the growth rate has come down a little, it is still high at around 17% annually. In late May or early June investors can expect the Board to announce another 17% dividend hike, which will bring the yield to 2.1%. With the growth rate expected to remain high for the foreseeable future, this solid dividend grower should continue to build income for dividend growth investors for years to come. The stock should be bought before the coming dividend increase.
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.