Is Dollar General the Perfect Addition to a Dividend Stock Portfolio?

Source The Motley Fool

Shares of Dollar General (NYSE: DG) are currently down 72% from their all-time high, the biggest reduction since the company went public again in 2009. It's a far from perfect company, as I'll explain. But this incredible drop in the stock price makes it a compelling addition to a dividend stock portfolio.

With dividend stocks, investors consider multiple factors. But among the most important considerations are the dividend yield, management's commitment to consistently paying the dividend, and the payout ratio (which I'll explain).

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According to GuruFocus, the dividend yield for the S&P 500 dropped below 2% in 2020, and has continue to fall to its current 1.2% yield. This means that for every $1,000 invested, you get just $12 in annual dividend income. This is about the lowest it's ever been for the index.

But for Dollar General, the dividend yield has never been higher; that's thanks to the steep drop in the share price. As of this writing, the yield is currently 3.3% -- nearly triple the average for the S&P 500.

DG Dividend Yield Chart

DG Dividend Yield data by YCharts.

Dollar General's dividend will provide shareholders with far better dividend income than the average stock in the S&P 500 -- as long as it continues to pay the dividend at its current rate. But how can investors be sure of management's commitment?

The company started paying dividends in 2015. Since then, it hasn't missed a quarterly payment. And it raised the dividend for eight consecutive years prior to 2024. But in 2024 it held the dividend steady, which ended its streak of increases. That said, the track record here is still quite good considering it hasn't missed a payment in ten years, and it's increased its dividend in eight of those years.

This demonstrates Dollar General's commitment to the dividend and leads me to believe it will continue for years to come. The only thing likely to derail it is a problem with the business, which is what some investors are worried about.

Why Dollar General isn't perfect

Dollar General won't report financial results for its fiscal fourth quarter of 2024 (which ends Jan. 31) until March. But it's expected to report full-year net-sales growth of about 5%, boosted by a modest increase in same-store sales. This is good.

Unfortunately, Dollar General's guidance indicated it anticipates full-year diluted earnings per share (EPS) of $5.50 to $5.90. At the midpoint, that would be a huge 25% drop from its diluted EPS in 2023. And this would continue a multiyear drop in profits, as the chart below shows:

DG EPS Diluted (TTM) Chart

DG EPS Diluted (TTM) data by YCharts

Here's why this is relevant to this discussion: Dividends are paid from earnings. If earnings drop, dividends get increasingly difficult for management teams to justify.

Dollar General is working to fix its profitability problem. Management blamed inventory management issues which had led to markdowns, theft, and damage. Regarding theft, the company is making progress. And inventory per store was down 7% year over year in the third quarter. So there's tangible progress here, albeit modest.

I believe it's a matter of when Dollar General works through its issues and profits rebound, not if it does. That's why I think the dividend is safe.

There's another reason to believe that the dividend is safe. As mentioned, dividends are paid from earnings, and this is measured with the payout ratio. The higher the ratio, the more of a company's profits are going toward the dividend. Therefore, a lower ratio is better from a safety perspective.

Right now, Dollar General is paying roughly $130 million per quarter to service its dividend. By comparison, its Q3 net income was about $200 million, which leaves plenty of room to spare.

In fact, over the last 12 months, Dollar General's payout ratio has been a very reasonable 38.8%:DG Payout Ratio Chart

DG Payout Ratio data by YCharts.

The takeaway here is that Dollar General's dividend should be safe because the payout ratio is low. And this is in spite of the company's ongoing problems. By contrast, if it fixes its problems (and there's already progress), then profits will increase and further lower the payout ratio, providing even more room for future dividend increases.

Dividend investors who buy Dollar General stock today will get a yield nearly triple that for the S&P 500. And the management team has shown commitment to raising the dividend in the past. This means that it would likely do so again as the business improves, only sweetening the deal for investors who lock in the dividend today.

Should you invest $1,000 in Dollar General right now?

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Jon Quast has positions in Dollar General. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Disclaimer: For information purposes only. Past performance is not indicative of future results.
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