Better buy: Flight Centre Travel Group Ltd or Wesfarmers Ltd?

A trap that investors often fall into is looking at company dividends in isolation to rank the merit of companies. Such a mistake is easy to make – if Company A earns a 7% dividend, and Company B earns a 4% dividend, then all other things being equal, Company A is obviously the better investment.

However, there is one fundamental thing that this method misses: that dividends are a function of profits. It then follows that a company can only increase its dividend sustainably if profits are also growing.

These two ASX stocks have been strong growth stocks and dividend payers, with both the share price and dividends increasing over the past several years.

But which way will profits and dividends move in coming years?

Flight Centre Travel Group (ASX: FLT) has several reasons why its total profits and therefore its dividends could grow in coming years. First and foremost is its dominant position as a face-to-face travel agent in its home market of Australia. The bright red stores are common in central business districts, large malls and sub-regional shopping centres across the country.

Flight Centre also has growth options overseas with corporate travel businesses, as well as retail operations in the United States, United Kingdom and Ireland to name a few.

It also has expanded its reach up and down the travel spectrum, buying smaller companies in niches that it can grow rapidly such as group tour company Topdeck Tours, as well as a bike company.

However, the outlook is not all clear skies for Flight Centre. The speed and ease of use of online travel agents has been exponentially increasing in recent years. Australians have shown that they are quick to transition to online buying of other major items such as cars, so it is logical to assume that more will gradually transition to purchasing their holidays online.

In addition, competitors in this space are global behemoths like Expedia and TripAdvisor, both of which dwarf Flight Centre in terms of size and resources.

Wesfarmers Ltd (ASX: WES) is another stock that has proven it has a competent management team and disciplined approach to strategy execution in recent years. The owner of Coles supermarkets and Bunnings is fortunate enough to have strong positions in two large, defensive sectors of the economy: non-discretionary grocery items and home maintenance and improvement.

It is also likely to maintain both of these positions in the medium term, with Bunnings having successfully seen off its only direct competitor in Masters, while Woolworths’ supermarkets continue to struggle without a clear strategy for winning back foot traffic and customer spending.

However, that does not mean that risks are not present to the profitability of Wesfarmers and by extension, its dividend. If Woolworths cannot arrest the fall in sales and profits, it is likely that management will be tempted by the “nuclear” option of an all out price war. In a competitive market, Coles would be forced to respond to protect its market share, and profits would naturally fall.

Management has also committed the company to a large scale expansion into home hardware in the United Kingdom, with plans to rebadge the struggling retailer Homebase. Whether the Bunnings model resonates with UK consumers remains to be seen, and the company will be up against a well-funded, entrenched number one competitor.

Foolish takeaway

Of the two stocks, Flight Centre appears to be more exposed to changing market forces and a dividend cut, while Wesfarmers may actually be able to raise its dividend if its foray into the UK proves successful.

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Motley Fool contributor Ry Padarath 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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