Dividend Report Card: Walgreen

In this series, we analyze financial metrics to begin answering the following questions about a company's dividend:

1. Over time, has this company steadily increased its payouts?

2. How sustainable is the dividend?

3. Does the company have room to further increase the dividend?

The Dividend Report Card wasn't designed as a buy or sell signal but rather as a tool to gauge the health of a company's dividend. For a full explanation of each category, click here for a tutorial.

Today's pupil is Walgreen (NYS: WAG) , which posts a 2.5% yield.

When we last looked at Walgreen in February, it scored near-perfect marks and just a few months later boosted its payout by 29%. Let's see if the future looks as bright this time around.

Dividend history

Source: Capital IQ, as of Sept. 14.

Over the past decade, Walgreen hasn't typically traded with a high yield, but it has been nothing short of a dividend growth darling.

Had you purchased 100 shares in September 2001, you would have received just $14 in dividends over the next 12 months. Had you reinvested those payouts, you'd have 110 shares today that will likely generate about $100 in annual income this coming year.

Nevertheless, past returns don't guarantee future results, so dividend history is only 10% of the final grade. Walgreen does, however, score a well-deserved 5 of 5 in this category.

Sustainability

Source: Capital IQ, a division of Standard & Poor's, as of Sept. 14.

Walgreen's interest coverage is a bit lower than stated due to substantial operating lease commitments that are kept off the official balance sheet. This is a common practice in the retail industry, but something we need to be mindful of because in many cases, those lease payments are non-cancellable.

Even if we made the adjustment to account for lease expenses, Walgreen's interest coverage would be more than adequate, so we won't ding the company in this category. Indeed, Standard & Poor's and Moody's both give Walgreen an "A"-equivalent credit rating.

Walgreen also generates more than enough profit and free cash flow to cover its current dividend, so the payout looks quite sustainable.

Growth

The company's stated dividend policy is to pay out between 30% and 35% of its profit. That's slightly above the roughly 26% payout ratio over the last 12 months, so Walgreen could certainly afford to pay more in dividends.

The median analyst estimate for long-term earnings-per-share growth is 13%, and based on its dividend health, I think Walgreen's dividend growth over the next five years could well match that pace.

Competitors
An "ungraded" section of the dividend report card is to see how a stock's current yield stacks up against that of direct competitors. If it's too high relative to competitors' yields, the board could be tempted to slow the growth rate, or vice versa, to bring it more in line with the industry average.

With its current yield at 2.5%, Walgreen's dividend is above this peer group, but is roughly in-line with the S&P 500 average yield of 2.3%, so it's not a major cause for concern.

Pencils down!
With all the numbers in, here's how Walgreen's dividend scored:

Well, this is a rare occasion -- it's not often that a stock scores an A+! I intentionally set up the grading on the Dividend Report Card to make scoring an A+ a difficult achievement, but Walgreen satisfies all the criteria and missed a perfect score of 5 by just one percentage point on the EPS payout ratio score in the growth category. Still, I think it's pretty safe to say that Walgreen might be as perfect a dividend growth stock as you'll find, and it should at least have a place on your watchlist.

Click here to add Walgreens to your watchlist

At the time thisarticle was published Todd Wenningis advisor of Motley Fool UK Dividend Edge. He does not own shares of any company mentioned. You can follow him onTwitter. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.