Dividend payments aren’t everything in a good investment. Just ask Warren Buffett. His Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) conglomerate doesn’t pay a dividend to shareholders, and he doesn’t intend to.
But that doesn’t mean Buffett doesn’t love receiving them. Berkshire’s 10 largest stock market holdings paid the company almost $3.8 billion in dividends in 2019.
For Buffett, what makes a great dividend stock is one that pays the dividends from funds left over after the company uses retained earnings to reinvest sufficiently back in the business. While Berkshire no longer owns any of this stock, Home Depot (NYSE:HD) is such a company, and the company’s track record on dividends is impressive.
Growing the business first
A great dividend stock first has to be a great company. As Buffett suggests, that means generating enough cash to first reinvest and grow the business. The home-improvement retailer certainly does that. It began a new One Home Depot investment program in 2018 that consisted of a three-year plan to invest $11 billion to build the company’s online channels and blend the digital and physical shopping experience for customers. In its recent fourth-quarter and full-year 2020 earnings call, Home Depot Chairman and CEO Craig Menear said the program remains on track with the “opening of various supply chain facilities, technology investments, and enhancements to the digital experience.”
The company has also been growing its business with the professional contractor base (Pros). To that end, the company acquired HD Supply, a supplier of maintenance, repair, and operations (MRO) products, in an $8 billion deal announced in the fourth quarter of 2020. The purchase reunites the two businesses after Home Depot previously sold it in 2007. The company supplies products for property managers and owners of multifamily, hospitality, commercial, healthcare, and government facilities in both the U.S. and Canada, and it will contribute to growing the Pros business.
Overall company sales grew by $21.9 billion, or 19.9%, in 2020, thanks in large part to the investments Home Depot has been making.
About that dividend
The company has been generating enough cash from its business to also consistently pay a dividend since 1987. It doesn’t qualify as a Dividend Aristocrat because it hasn’t increased the payout every year for at least 25 consecutive years. But it is heading in that direction. Home Depot has raised the dividend yearly since 2009, including another 10% increase it just announced for its upcoming payout in March 2021.
A good chance to buy
The year 2020 was an exceptional one for the company, as the pandemic accelerated the desire for do-it-yourself home projects. Sales growth actually increased in the latter part of the year, with 25.1% fourth-quarter growth versus the prior-year period. But since the company reported its fourth-quarter results on Feb. 23, Home Depot share prices have dropped approximately 8%.
One reason may be that investors didn’t like the company’s 2021 guidance. Richard McPhail, executive vice president and CFO, said in the earnings release that if the demand environment seen during the latter half of 2020 continues through 2021, the company expects to see “flat to slightly positive comparable sales growth.”
That may not have impressed investors at first, but considering the large revenue jump the company experienced in 2020, the bigger growth picture still looks impressive, even if revenue flattens this fiscal year.
Investors looking for a great dividend stock have one in Home Depot. Just as what Warren Buffett looks for in his stock investments, the company focuses on growing the business before sharing excess cash with investors. That approach helps increase the likelihood that both the business and the dividend will continue to grow over time.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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