How can an investor be sure that a company is of high quality? Investing is as much an art as it is a science, but outperforming the market over at least five years is typically a good sign.
Delivering 28.7% annual total returns over the last five years, the home retailer Williams-Sonoma (WSM 0.15%) dramatically outpaced the S&P 500 index's 12.8% annual total returns during the same period. A $10,000 investment in the retailer would now be worth over $35,000 with dividends reinvested. For context, this is nearly double the $18,000 the S&P 500 index would have parlayed the same investment into in that time.
But is Williams-Sonoma's stock still a buy for dividend investors? Let's dig into the company's fundamentals and valuation to find out.
Strong brands and a favorable customer demographic
For those who aren't familiar with Williams-Sonoma, the kitchen and home furnishings retailer owns a variety of well-known brands. These include the eponymous Williams-Sonoma, Pottery Barn, West Elm, and Mark and Graham.
The company reported $2.1 billion in net revenue for the fiscal second quarter that ended on July 31. This works out to a 9.7% year-over-year growth rate. Williams-Sonoma's results for the quarter stood above most other retailers. How was this possible?
High inflation is costing the typical American household several thousand dollars more than last year alone. Since wage increases haven't kept up, this has eaten away at the discretionary income of most households.
What makes Williams-Sonoma quite unique is the profile of its customers. Because its products appeal mostly to households belonging in the upper class economically, demand has remained solid. That's because higher prices at the pump and at the grocery store have less of a negative impact on the discretionary income of those at the top rung of the economic ladder. This is how Williams-Sonoma's comparable brand revenue surged 11.3% year over year.
The company's diluted earnings per share (EPS) soared 20.6% to $3.87 during the quarter. Higher costs actually led Williams-Sonoma's net margin to fall 14 basis points over the year-ago period to 12.5%. However, a 9.8% decline in the company's outstanding share count to 69.1 million due to share repurchases more than offset this slight drop in profitability.
Along with share repurchases, continued investment in the company's existing brands and acquisitions will grow the company's market share in the $830 billion home retail market.
Image source: Getty Images.
The dividend can keep compounding
Investors focused on passive income will appreciate the fact Williams-Sonoma's 2.3% dividend yield is significantly higher than the S&P 500 index's average 1.7% yield. And the icing on the cake is there is plenty of room for future growth in the payout, which has already increased annually for more than a decade.
Williams-Sonoma's dividend payout ratio is just 18%, and dividend growth should moderately outpace earnings growth for the foreseeable future. That's why I'm expecting high-single-digit annual dividend growth for the next several years.
A wonderful business at a discounted valuation
Williams-Sonoma's fundamentals are robust. Yet the market doesn't seem to fully appreciate the stock.
Its forward price-to-earnings (P/E) ratio of 8.1 is below the luxury goods industry average of 10. This makes the dividend stock a tremendous buy for dividend growth investors.
