Walgreens Can Fill Your Prescription for Dividends



Walgreens has increased its annual dividend for 36 consecutive years. Yes, you read that right; Walgreens has increased its annual dividend every year since 1976. That’s an impressive feat for any company, but particularly impressive for a specialty retailer. Walgreens is different from many specialty retailers, however, in that they sell a service that is not as sensitive to swings in the economy as others. More than 65% of the company’s sales come from filling prescriptions for its customers. The company looks to be well-positioned to continue to grow its dividend as it recently has reduced the amount it spends on opening new stores. That should leave more cash flow for shareholders, going forward.

Current Dividend Yield

Of the five dividend-paying stocks included on our Dividend-a-Month Club list for September, Walgreens has the second lowest current dividend yield (2.52%) – slightly higher than IBM. Interestingly, IBM and Walgreens ranked number one and two, respectively once all of the September stocks were run through our dividend selection model. You may be wondering how this can be. Why aren’t the stocks that have higher dividend yields ranked higher on a list of best dividend stocks? While the current dividend yield is an important factor to consider, it is not the only factor. Equally, if not more, important is the company’s history of growing its dividend, as well as its ability to maintain that growth, going forward.

Dividend Growth History

To be included in the First Share Dividend-a-Month Club, a company must have raised its dividend each year of the previous five years and Walgreens fills that requirement. As previously mentioned, Walgreens has raised its dividend for 36 consecutive years and during that period has increased its dividend by an average of 13.6% per year (compounded). Since 2005, the company’s dividend growth rate has accelerated to 22.7% per year, compounded annually.

Dividend Sustainability

To get more on my thoughts of the importance of dividend sustainability, please check out my dividend analysis of IBM. To summarize, I believe that this is the most important factor to consider when accessing a company’s dividend. Any company can essentially mortgage its future to pay its shareholders a fat dividend for one year, but only the most financially-stable companies can continue to pay an attractive dividend over the long-term.

To gauge a company’s dividend sustainability, I look at the company’s payout ratio, or its dividend per share divided by its free-cash-flow per share. This ratio tells you what percentage of a company’s annual free cash flow it is paying out as a dividend to its shareholders. Generally, the lower the better because it provides the company with more of a financial cushion should it go through a down period.

For 2011, Walgreens is on track to pay out approximately 31% of its free cash flow as a dividend, so its payout ratio is just that, 31%. That is below its five year average payout ratio of 36%. In my opinion, this is a very solid number and gives the company plenty of room to increase its dividend, going forward. In fact, the company just recently increased its quarterly dividend by 29% to $0.23 per quarter ($0.92 per year). Theoretically, the company could also increase its payout ratio and, therefore, pay an even larger dividend, but, with the exception of 2007 and 2008, Walgreens has been fairly consistent in paying out 20% – 30% of its annual free cash flow in dividends. The high payout ratios during 2007 and 2008 are anomalies as the company was investing heavily in building new stores during that period, so its free cash flow was artificially low.

Yield-to-Cost Explained: If you were to buy shares in Walgreens at its current price of $35.88 and received $0.92 per share in dividends, your yield-to-cost would be 2.6%. Yield-to-cost is determined by simply dividing a company’s dividend by the investor’s average cost basis in a stock. Assume, for example, that Walgreens were to continue to increase its dividend by its long-term average rate of 13.6% per year. By 2016 it would be paying an annual dividend of $1.51 per share. If you paid $35.88 per Walgreens share today and held the stock through 2016, you would essentially be receiving a dividend yield (on your investment) of 4.2% in 2016.

Conclusion

Walgreens has a solid history of maintaining, and growing, its dividend. Given its low payout ratio, it appears as though the company will be able to sustain that growth, going forward. While its current dividend yield is the second lowest of our September picks (2.52%), investor’s who purchase the stock at current prices could see their yield-to-cost rise significantly over the course of the next several years.

Walgreen shares are offered as part of the First Share program for DRIP investors.

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