Lowe’s Stock: Relatively Low Yield, Strong Dividend Growth (LOW)

Many investors who purchase equities like to receive some income from their investments. Kevin O’Leary is a famous investor who runs his own ETF, and he claims that he won’t own stocks that don’t pay out dividends. It’s possible that an investor could purchase a stock that gets hot and then crashes to nothing. Without a dividend, this investor would never see a return on capital unless she sold some of her shares before the bankruptcy.

Dividends return a share of the profits to investors, who can then use them to do basically anything they choose. They can pay for bills or living expenses. They can reinvest them into more shares of the company that paid them. They can also put the dividends toward other stocks or ETFs to diversify their holdings. Investors who own several ETFs or dividend-paying stocks can get to the point their dividend income can handle their living expenses without their having to sell any shares. This is why dividend investing is a popular strategy. It’s one that I’m utilizing. Outside of ETFs in my retirement account, I own no stocks that pay no dividends.

Yield or Growth?

There are some writers here on Seeking Alpha who focus on finding stocks that pay out high yields that are relatively safe. I’ve benefited from reading these articles and hold some high yielding investments in my account. There is the fear that these stocks will cut the dividend because of the high yield, but there is also the possibility that stocks with lower yields will cut their payouts. I once owned General Electric (GE) stock when it yielded in the 3% to 4% range, but the company still cut its payout to $0.01 per quarter. Fortunately, I had already sold out of the position before taking a major haircut on my dividend income. It’s important to keep up with a company’s financials to avoid dividend cuts, but a low yield is not necessarily safe.

Other people decide they want to focus on lower-yielding stocks that pay out steadily increasing dividends. The yield and the dividend payments start out low, but they can grow over time to be something really impressive. Warren Buffett’s purchase of Coca-Cola (KO) is one of his most famous and lucrative purchases. Today, because of dividend growth, Buffett receives a whopping 54% of his initial purchase price in dividends each year, and that number is growing.

Because his cost basis, when accounting for stock splits, is $3.25 a share, the current $1.76 annual dividend is 54% of his purchase price. The annual dividend when he bought the shares was $0.075 per share on a split-adjusted basis, which was a 2.3% starting yield. Of course, it took more than 30 years to build up to this level of yield on cost, but it’s an impressive record.

Those with a long investing horizon would do well to buy stocks that promise to grow their dividends over the long run.

My Strategy

I’m currently using a hybrid approach. I have some stocks with high yields in my portfolio, but I also want to have some stocks with low yields that promise income growth over time. I recently invested money that I’d taken off the table when I knew I was getting ready to buy a home. I did not want to have a massive loss when I might need some cash for a down payment. After closing my home loan, I decided to invest the money again, and I wanted to purchase some shares in companies that have relatively low yields with high growth. For this portion of my portfolio, I decided to go with Lowe’s Companies (NYSE:LOW).

Lowe’s As A Dividend Stock

Lowe’s is one of the major home improvement retailers in the country. If you were to ask most people to name a home improvement company, Lowe’s and Home Depot (HD) are likely to top the list. As long as people own houses, individual home owners and contractors are likely to need what Lowe’s is selling.

Over the past 10 years, Lowe’s has increased its revenue from $50 billion to more than $96 billion. To say the least, this is a healthy growth in sales. Net income has also grown, although this has not been a straight line. The 2012 annual report had a net income of $1.959 billion, which compares with a number of $8.442 billion for the annual numbers that came out a year ago. Most years over the past 10 have come in the $2-$4 billion range.

The revenue and income numbers are solid, to say the least. When looking at earnings on a per share basis, they’ve also grown over the past ten years, from $1.69 to $12.04, although the latter number was a bit of an outlier. However, there has been steady growth with the exception of 2018, which was the only year that saw a year-over-year decline.

EPS might grow even more in the near term. Lowe’s is expecting earnings per share of around $13.65 this year, and the company just announced a $15 billion share buyback program. This was in addition to $4.7 billion that still remained on a previous buyback program.

The company has bought its own shares aggressively over the past decade. Back in early 2013, the company carried 1.15 billion shares on its books. As of the last annual report, that number was down to 696 million, a decrease of nearly 40% of its shares. The company currently has a market cap of $126 billion with nearly $20 billion approved for buybacks. This could drop the share count by 15% from its current level (although according to Seeking Alpha, the share count on a TTM basis is already down to 649.5 million).

The lower the number of shares available on the market, the higher the claim each individual investor has to the company’s profits. Also, that means that fewer shares require a dividend payment, which could lead to higher increases.

Lowe’s has a relatively low yield at present. It’s currently right around 2%, and it has been in that general vicinity since I bought shares in late November. This is definitely not a high yielder when compared to stocks or funds that yield 4%, 5%, or even 12%. However, the company has a massive dividend growth streak. LOW has paid a higher dividend for 59 straight years. It’s definitely a dividend king.

Unlike many companies with long dividend growth streaks, Lowe’s is growing at a rapid pace, and this is one of the things that attracted me to this particular stock. Over the past five years, the company has averaged a dividend increase of 19.47%. If the company can continue raising dividends at this rate, the dividend will more than double every four years based upon the Rule of 72.

This means that the small 2% yield on cost would rise to a little more than 4% in four years, more than 8% in eight, 16%+ in 12, and so on. Past performance is not a definite indicator of future returns, but this scenario is within the realm of possibility given the long dividend growth history.

Over the past 10 years, even with this high rate of dividend growth, the payout ratio has actually dropped. For FY 2012, the ratio was 35.94%. Today, that number is 27.97%. In only one year over the past 10 was the payout ratio more than 40%.

The only concern that gives me a bit of pause related to an investment in LOW is its increased debt load. The current long-term debt held by the company clocks in at more than $32 billion, which is up substantially from the $9 billion it held in February 2013. The company should be reticent to take on much more debt to avoid problems in the future. Higher debt levels can lead to lower credit ratings and higher interest rates. They can also lead to difficulty in keeping up with other obligations.

Conclusion

Lowe’s is a company that has a strong track record. It’s grown sales and income substantially over the past decade (and prior). It has a wide footprint across the nation, and homeowners need the products it sells. As the nation’s population grows, there will be even more people who need to make purchases from companies like Lowe’s and Home Depot. An aggressive buyback program has helped the company pay out increasing dividends while also increasing its EPS. Because of the impressive dividend growth history exhibited by LOW, I decided to purchase a few shares. My hope is that what might seem to be a relatively small share of my dividend income will grow to a healthy level over the next couple of decades. Given the company’s track record, this appears to be a distinct possibility.