Dividend stocks can be spectacular capital appreciation vehicles. The main reason is that companies that pay regular cash distributions tend to be mature, have durable competitive edges, and enjoy a loyal shareholder base. However, dividend-paying companies can also face challenges that affect their earnings, share price, and yield.
Sometimes, companies can overcome these difficulties and promptly return to growth. More often than not, though, struggling dividend payers must rethink their capital allocation strategy, which can lead to a substantial reduction in the dividend.
That brings us to the subject of this article: Walgreens Boots Alliance (NASDAQ: WBA). With over 8,500 locations, Walgreens is one of the largest retail pharmacy chains in the United States. The company reports earnings via three segments: U.S. retail pharmacy, international, and U.S. healthcare.
Thanks to novel competitors entering the retail pharmacy market and a slowdown in COVID-19 product sales, Walgreens’ shares have tumbled by a staggering 43% over the prior 12 months. Consequently, its yield has risen to a noteworthy 9%, which also happens to be the highest yield among Dow Jones Industrial listed stocks currently.
Is it time to catch this falling knife? Let’s dig deeper to find out.
Walgreens’ high dividend yield and elevated debt-to-equity ratio (121.4%) have attracted a lot of attention from the financial media. The singular reason is that these factors are widely believed to be a recipe for poor share price performance in both the short and long runs. However, academic research on this topic suggests the relationship among debt, dividends, and returns is more nuanced.
Specifically, the research shows that debt level is not a major obstacle for dividend stocks in terms of their annual performance. Many top-shelf dividend stocks have high debt-to-equity ratios.
For example, the average debt-to-equity ratio of Dividend King stocks (companies that have increased their dividends for at least 50 years) is currently 167%. Among these companies, 20% have beaten the S&P 500 index since 2017, and 84% have delivered positive returns to shareholders over the same time frame despite their high leverage.
The dividend yield is not a simple indicator of stock performance, either. When dividend yields are higher than the S&P 500 average (around 1.62%), they tend to signal lower returns over one-, five-, and 10-year horizons. This isn’t a hard and fast rule, but the data show that very few stocks above this critical threshold deliver market-beating returns over these time frames.
Walgreens is pursuing a strategic shift that involves entering the healthcare market’s primary and urgent care segments. These high-growth opportunities could boost the company’s earnings power over the long run.
However, Walgreens faces fierce competition in these areas, and its high dividend yield is likely to weigh on its stock price while this strategic shift plays out. The point is that Walgreens stock doesn’t screen as a particularly appealing capital appreciation play with its dividend at sky-high levels.
That being said, Walgreens stock does come across as an intriguing income vehicle. The company has a rich tradition of paying dividends, and its payout ratio of 38.1% over the past 12 months indicates it should be able to maintain its quarterly distribution. However, its new leadership might decide to cut the dividend to boost the company’s appeal to growth investors, a risk factor the income crowd should carefully weigh before buying shares.
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