(Published March 31 by Bob Ciura)
Wal-Mart Stores Inc. (WMT, Financial) and Costco Wholesale Corp. (COST, Financial) are fierce competitors within the discount retail space.
Both are highly profitable, large-cap stocks. In addition, both pay dividends to shareholders.
But while they are both dividend stocks, they have many differences.
Wal-Mart is a member of the Dividend Aristocrats, a group of companies in the S&P 500 that have raised dividends for at least 25 years.
You can see the entire list of Dividend Aristocrats here.
Meanwhile, Costco is a Dividend Achiever, a group of 271 stocks with 10-plus years of consecutive dividend increases.
You can see the full Dividend Achievers List here.
We will discuss three reasons why Wal-Mart is a better dividend stock than Costco.
Reason No. 1: E-commerce
The most important growth catalyst for big-box retail is e-commerce. Costco and Wal-Mart are both investing in their e-commerce platforms simply out of necessity.
Amazon.com (AMZN, Financial) and other Internet retailers pose a huge risk to brick-and-mortar retailers due to the convenience of at-home shopping and low prices they can offer to consumers.
As a result, it is imperative that physical retail catch up in e-commerce.
Wal-Mart has a huge advantage because it is one of the only companies with the financial strength to pose a credible challenge to Amazon’s quest of world domination.
Source: Raymond James Institutional Investors Conference, page 6
This is particularly true when it comes to online grocery shopping. Groceries are an increasingly attractive area of growth for Wal-Mart and Amazon.
Thanks to its massive size and scale, Wal-Mart has the financial flexibility to maintain low prices.
Wal-Mart does not charge extra for online grocery orders picked up in-store. This is why the company has emphasized in-store pickup within its e-commerce strategy, while Costco focuses more on third-party delivery services.
For example, Costco recently announced a partnership with grocery delivery service Shipt. The partnership will initially launch in Tampa, Florida, with plans to expand into 50 markets by the end of 2017.
There are two potential disadvantages to Costco’s strategy however. First, the service requires a membership, which costs $99 per year.
Second, grocery delivery is fraught with pitfalls. Groceries are perishable items that require refrigeration. This presents significant logistical hurdles that Costco will have to overcome.
As a result, Costco’s strategy of relying more heavily on third-party delivery services could weaken its position among cost-conscious consumers, particularly if the quality of the groceries do not meet consumer expectations.
This shows the benefits of being the industry leader. Wal-Mart has invested billions in its e-commerce platform, both organically and through acquisitions.
Source: Raymond James Institutional Investors Conference, page 12
Wal-Mart acquired e-commerce platform Jet.com for $3.3 billion in September 2016.
Walmart.com is the third-most visited U.S. retail website. Wal-Mart’s e-commerce global e-commerce sales more than doubled from 2014 to 2016.
Last year, Wal-Mart generated approximately $15 billion in global e-commerce sales.
Wal-Mart’s e-commerce sales rose 29% in the fourth quarter of 2016, and 22% for the full year. The company has a huge global e-commerce footprint, both in the U.S. and attractive emerging markets like China.
Wal-Mart owns a 10% investment stake in Chinese e-commerce giant JD.com.
Costco has a successful e-commerce business as well, just on a much smaller scale. Costco’s e-commerce sales rose 15% in 2016, but its e-commerce platform still represents less than $4 billion in annual revenue.
Therefore, Wal-Mart appears to be the retailer best positioned to fight the 800-pound gorilla in e-commerce, Amazon.
Reason No. 2: Dividend yield & history of dividend growth
The second reason to prefer Wal-Mart over Costco is because of its higher dividend yield and longer history of dividend growth.
Wal-Mart’s annualized dividend of $2.04 per share provides a 3% dividend yield. On the other hand, Costco’s current dividend yield is just 1.1%.
Based on their respective dividend yields, Wal-Mart stock will generate nearly three times as much dividend income as Costco.
In addition, Wal-Mart has a much longer history of raising its dividend.
While Costco has raised its dividend for more than 10 years, Wal-Mart has increased its dividend for 44 years in a row.
With another six years of dividend increases, Wal-Mart will reach an even more exclusive club than the Dividend Aristocrats: The Dividend Kings, a group of 19 companies with over 50 years of consecutive dividend increases.
You can see the entire list of Dividend Kings here.
This demonstrates Wal-Mart’s commitment to providing shareholders with an attractive dividend yield and raising its dividend consistently no matter what.
Costco typically raises its dividend at higher rates—it increased its dividend by 12% last year, versus a 2% dividend bump for Wal-Mart.
But part of why Wal-Mart has reduced its dividend growth rate in recent years is so that it could free up additional cash flow to invest in major growth catalysts like e-commerce.
Wal-Mart’s capital expenditures are likely to exceed $11 billion this fiscal year.
Such massive investments mean investors have to settle for low single-digit dividend increases, but Wal-Mart’s strategic investments have paid off.
Reason No. 3: Profitability & valuation
Lastly, Wal-Mart is a more attractive stock because it offers margins of safety in the form of higher profit margins and a lower stock valuation.
In fiscal 2016, Wal-Mart generated $13.6 billion of net income on $486 billion of total sales. This means Wal-Mart had a profit margin of 2.8%.
Meanwhile, over the first half of Costco’s current fiscal year, the company generated a profit margin of 1.8%.
Wal-Mart’s profit margin exceeds Costco’s by a full percentage point.
This allows Wal-Mart the ability to pay higher dividends. In addition, its stronger profitability is combined with a lower stock valuation.
Based on its recent share price, Wal-Mart stock trades for a price-earnings ratio of 16. By contrast, Costco has a price-earnings ratio of 31.
This means Costco’s stock valuation is nearly twice as high as Wal-Mart’s.
For context, consider the S&P 500 Index has an average price-earnings ratio of 26.
To be sure, it is not unexpected to see growth stocks hold higher valuations, but Costco’s growth has slowed in recent periods.
Source: 2016 Annual Report, page
Costco grew comparable sales, a crucial measure for retailers that shows growth at locations open at least one year, by 2% over the first half of the company’s current fiscal year.
Wal-Mart’s fourth-quarter comparable sales increased 1.8%, and the company expects 1% to 1.5% growth this fiscal year.
This leaves Costco stock vulnerable to contraction of the price-earnings ratio, particularly if investors begin to question the company’s growth outlook.
Final thoughts
Costco has historically been known as more of a growth stock, while Wal-Mart is a classic dividend yield and value play.
But this could be about to change. While Costco’s growth has slowed recently, Wal-Mart’s growth is accelerating after massive investments in its supercenters and e-commerce businesses.
While dividend growth investors with a longer time horizon may see reason to buy Costco for its higher dividend growth, income and value investors should stick with Wal-Mart.
Disclosure: I am long WMT.
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