The Motley Fool

Why Woolworths Limited should be in your portfolio

Many investors and analysts often describe Woolworths Limited (ASX: WOW) as a stock that is past its growth days. However, I believe a combination of near double-digit earnings per share growth and a steadily increasing dividend yield make it one of the best and safest long-term investments on the ASX.

Over the past 10 years, Woolworths has increased its dividend from 18c per share in 2003 to 62c per share in 2013, an increase of 244%. The nature of Woolworths’ business means that it is able to generate huge cashflow from a reliable and defensive earnings stream and therefore it is highly likely that the increase in dividends witnessed over the past 10 years will be repeated again over the next 10 years. While the current dividend yield is still an attractive 4%, investors buying the shares today with a longer-term focus will likely be the beneficiaries of substantially higher dividend yields over the next 10 years – perhaps as high as 20% on today’s share price.

Although Woolworths will likely not see the same high levels of earnings growth going forward as that achieved over the past decade, analysts at UBS have still forecast earnings per share growth of almost 10% over the medium term as a result of the following factors:

1) An increase in food inflation. Every 1% increase in food inflation results in an approximately 2% increase to Woolworths earnings. Food inflation is currently at near record lows and is forecast to increase throughout 2014 and 2015.

2) Increased earnings growth in the grocery division as a result of recently opened stores continuing to gain customers and recently implemented marketing initiatives and loyalty programs.

3) A profitable Master’s division. Although Woolworths’ Master’s home improvement stores are currently loss making, over the medium-term Master’s will be profitable. The market has currently not factored this into the share price given the short-term focus of analysts.

4) Woolworths has invested heavily in new capital expenditure over the last five years, however capital expenditure is now easing and will result in increased cashflow and higher dividends to shareholders.

The combination of solid earnings per share growth and an increasing dividend yield means that investors should get a return of in excess of 15% annually from Woolworths over the next decade. This return makes it one of the safest investments on the ASX and a great way to build long-term wealth.

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Motley Fool contributor Bradley Murphy owns shares in Woolworths mentioned in this article. 

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