Want Rising Passive Income? Buy This Dividend Growth Machine

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The strategy behind dividend growth investing centers around buying quality companies with strong underlying fundamentals and a culture of rewarding shareholders. I define strong fundamentals as consistent growth in both the top line and bottom line because this allows a trickle-down effect in terms of dividend growth.

The rural lifestyle retailer, Tractor Supply (TSCO 3.51%), is arguably a great dividend growth pick. Since initiating its quarterly dividend of $0.04 per share in 2010, the company grew its payout by a staggering 2,200% to $0.92 per share. It would be unreasonable to expect this kind of growth to be replicated in the next decade. But Tractor Supply likely will have plenty of dividend growth in its future, making it a great buy for dividend growth investors. Let’s drill down into why this will be the case. 

Tractor Supply continues to churn out impressive growth

With more than 2,200 stores, including its 180 small-box pet specialty retailer stores called PetSense, Tractor Supply is the biggest rural lifestyle retailer in the U.S. This uniquely positions the company to take advantage of a shift in preference from urban living to rural living among consumers. The share of respondents to a Gallup poll wanting to live in a town or rural area has surged from 39% in the pre-pandemic year of 2018 to 48% as of 2020.

This renewed interest in a rural lifestyle among Americans played right into the hand of Tractor Supply. That’s how the company’s net sales increased 8.4% year over year to $3.3 billion in the third quarter (which ended Sept. 24). 

Digging deeper, Tractor Supply’s comparable-store sales grew by 5.7% over the year-ago period during the quarter. Simply put, existing locations benefited from an increase in total demand for products as more individuals moved into the small towns and rural areas that the company serves. Coupled with a 2.9% year-over-year increase in its total store count to 2,207 to reach more communities, this fully explains Tractor Supply’s high-single-digit percentage net sales growth for the quarter. 

The company recorded $2.10 in diluted earnings per share (EPS) in the third quarter, which was up 7.7% over the year-ago period. A faster increase in cost of merchandise sold (8.9%) than net sales resulted in a nearly 30-basis point year-over-year drop in net margin to 7.2% during the quarter. Tractor Supply’s 3.2% reduction in its outstanding share count to 111.6 million via its share repurchase program was able to offset much of the dip in profitability. This is how diluted EPS growth only slightly fell behind the pace of net sales growth in the quarter. 

As urban residents flock to small towns and rural areas for affordable housing and the tranquility of the lifestyle, Tractor Supply should continue to profit from this trend. That is why analysts forecast 10.5% annual diluted EPS growth over the next five years for the company. 

Image source: Tractor Supply Co.

Market-matching passive income with tremendous growth potential

Tractor Supply’s 1.7% dividend yield is in line with the S&P 500 index’s 1.7% yield. But what really sets the company apart is its massive dividend growth prospects. 

Tractor Supply’s dividend payout ratio will be a tad above 38% in 2022. That low payout ratio has two benefits to shareholders: First, it leaves the company with enough funds to invest in future growth opportunities, repay debt, and repurchase shares. Second, Tractor Supply has plenty of room to maintain its dividend through a temporary downturn in its business. This is why I expect low-double-digit annual dividend growth from the company over the next several years. 

A fair valuation for a wonderful business

Tractor Supply is executing its plans to bring stores to communities where the demand for its products is there. And the stock is a decent value to investors at the current valuation.

Tractor Supply’s forward price-to-earnings (P/E) ratio of 22.4 is comparable to the S&P 500 consumer discretionary sector average forward P/E ratio of 22.3. That’s hardly a steep premium to pay for the quality of the stock. And this makes Tractor Supply a buy for dividend growth investors looking to also outperform the broader market potentially.

Kody Kester has no position in any of the stocks mentioned. The Motley Fool recommends Tractor Supply. The Motley Fool has a disclosure policy.



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