Should you ignore Woolworths Limited’s fully franked dividend yield?

Credit: Woolworths

Buy-and-hold investors generally aim to utilise share price weakness as an opportunity to add high quality companies to their portfolio.

Right now many long term investors are surely running the ruler over Australia’s largest retailer Woolworths Limited (ASX: WOW).

Despite rallying around 15% from its 52-week low of $20.30, investors have actually had few windows of opportunity to buy Woolworths shares at a lower price over the past decade.

Why is the share price so low?

There are numerous factors which have led to the sell-off in Woolworths shares.

These problems include the underperformance (and subsequent decision to exit) the Masters hardware joint venture.

The underperformance of discount department store chain Big W – which recorded a loss of $15 million for financial year (FY) 2016 – is also a contributing factor.

The biggest issue facing the group however – and almost certainly the biggest concern for investors – remains the pressure on the supermarket division’s profit margin.

Increased levels of competition from a rejuvenated Coles, owned by Wesfarmers Ltd (ASX: WES), along with the growing market penetration of Costco and particularly Aldi has led to a constriction in Woolworths’ previously world-leading profit margin.

This competitive pressure from Aldi and others isn’t likely to go away which means Woolworths may never again achieve its historic profit margin.

This lower margin scenario could rightly mean that Woolworths faces an uphill struggle to be as profitable as it once was.

With the group recently reporting its full year results, investors have plenty of financial data to wade through and analyse.

Earnings per share (EPS) before significant items fell 39% to 123.3 cents per share (cps). Meanwhile, full year dividends totalled just 77 cps down from 139 cps in the prior year.

It certainly wasn’t a good year for shareholders, however, the future does look brighter.

According to analyst consensus estimates, FY 2016 is expected to represent the trough in earnings with a higher EPS result forecast for both FY 2017 and FY 2018 (source: Reuters).

Over the past decade, Woolworths has had an average pay-out ratio of around 70%.

Based on the consensus EPS estimates for FY 2017 and assuming a 70% pay out, shareholders could potentially receive dividends of 86 cps in the coming 12 months.

With the shares currently trading at $22.95 this implies a fully franked yield of 3.7%.

Arguably that’s an attractive yield considering the defensive positioning of the business, the rebasing of earnings and the potential for improved profit results from this point.

If you are interested in quality dividend shares, then I would recommend this top dividend share instead. A strong yield and potential share price gains make this a great investment idea in my opinion.

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Motley Fool contributor Tim McArthur has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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