There are a lot of things that one must consider
prior to buying stock in a publicly-traded company. Some of these
things include the strength of a company's business model,
geographic diversification, financial condition, valuation, and
Another important concern is the dividend that the
company in question pays out. Strength and sustainability of the
dividend are very important for dividend growth investors. In fact,
did you know that 42% of the total return of the S&P 500 over the
last 80+ years came from dividends? This is why dividends are so
important for any investment portfolio.
Today, let's dig into the consumer goods sector and
check out the dividends from Coca-Cola and PepsiCo. As most
everyone knows, these two companies are the biggest players in the
non-alcoholic beverage industry. PepsiCo also has a huge presence in
the snack foods industry. We will
look into the dividend history of each company, its historical
dividend growth rates, whether or not each company's dividend is
supported by cash flows, and whether the companies can sustain their
dividend growth rates in the future.
When talking about a
company's dividend, the first thing that normally comes to mind is
the dividend yield, which is the percentage of your capital that you
receive in return over the next 12 months, as long as the dividend
amount is not changed. Here are the dividend yields from both Coca-Cola
Table 1: Dividend Yields of Coca-Cola and PepsiCo
The dividend yields of both of these companies are
the same, at 3.3%. These dividend yields reflect the dividend
increases that were announced by each company earlier this month.
PepsiCo's increased payout doesn't take effect until June, so these
are forward yields, not trailing ones. The dividend yields of both
companies are at their highest levels in some time. The yield of
Coca-Cola is at its highest point since July 2010, 3 1/2 years ago.
PepsiCo is showing its highest dividend yield in two years.
The dividend yield is just one of many factors that
need to be considered when it comes to the strength of a company's
dividend. A company's stock can have a high dividend yield due to an
unsustainable dividend payout ratio, or poor fundamentals that have
brought down the stock price. These items could then lead to a
dividend cut, which will reduce your yield on cost.
Dividend growth should also be considered. This is
because a company that increases its dividend payout every year
maintains the purchasing power of the income streams that are
received by its investors. If dividend growth rates can't keep up
with inflation, then investors are really losing money when they
consider the loss in purchasing power. Dividend increases also
signal a strong outlook by management and underscores their
commitment to shareholders. Many companies regard their dividends as
a sacred cow. Over time, dividend growth can supercharge an
investor's yield on cost. Consider Warren Buffett, who started
buying Coca-Cola back in the '80s. Now, he receives a yield on cost
of 40%, and growing every year as long as Coca-Cola keeps increasing
their payout. Sounds like a pretty good deal, no?
Let's see how the dividends of Coca-Cola and PepsiCo have grown over the last 5 years. The numbers in the table
represent the average dividend growth rate over the last five years.
Table 2: Five-Year Dividend Growth Rates of Coca-Cola
Both of these companies have shown outstanding
dividend growth rates over the last five years, easily outpacing the
erosive effects of inflation. Here, Coca-Cola wins it by a nose.
Coca-Cola has had the most consistent dividend growth of the two,
with annual dividend growth ranging between 7% and 10% over the last
five years. The dividend increase that was announced last week
represents an 8.9% increase, inline with what they have done in the
past. Coca-Cola has now increased its dividend every year for the
last 52 years! PepsiCo's recently announced dividend increase is 15%
above its current payout. However, in the five years leading up
until now, their dividend growth has ranged between 4% and 7%.
PepsiCo has now increased its dividend every year for 42 years!
These strong dividend histories could not have happened
without each company's exceptionally strong business models and
brand strength. For right now, Coca-Cola is the winner, when
looking at dividend growth over the last five years.
Dividend Payout Ratio
High dividend yields and strong growth rates are all
well and good, but we need to make sure that the company in question
is making enough money to keep the dividends going. This is where
the dividend payout ratio comes in. The payout ratio is the
percentage of the company's profits that get returned to
shareholders in the form of dividends. You usually like to see this
ratio at 60% or below, as that will insure that the dividends will
continue to get paid, even if the company experiences a downturn
over a short period. Dividend payout ratios that approach or exceed
100% may signal future dividend freezes or cuts, which are not good
at all for investors.
The table below shows the dividend payout ratios for
Coca-Cola and PepsiCo, both on a trailing twelve month and a
four-year average basis. The earnings that I used in these
calculations are referred to as core earnings, which remove one-time
items that don't have an impact on the company's operations.
Table 3: Dividend Payout Ratios of Coca-Cola and
From the looks of Table 3, the dividend payments of
both Coca-Cola and PepsiCo are in excellent shape. None of
them appear to be in any danger of getting cut. The current payout
ratios are inline with the four-year averages.
While both companies are looking very good in this
category, PepsiCo is just a tiny bit better here, with a
lower payout ratio, both on a trailing 12-month basis and a
4-year average basis. However, it will be interesting to see how
this changes after PepsiCo's 15% dividend hike takes effect.
How About That Free Cash Flow?
A lot of folks would end their analysis after
calculating the dividend payout ratio. However, we need to keep in
mind that that figure is based on dividend payout as a percentage of
earnings, not actual cash that comes into the business over a
certain period of time. Earnings often contain items like
depreciation, asset impairments, actuarial gains on pension plans,
and other non-cash items that can distort the picture as to how
healthy a company's dividend really is. For this reason, I like to
calculate the free cash flow payout ratio, which shows us what
percentage of cash that comes in over a 12-month period gets
distributed to shareholders. This paints a more accurate picture
when it comes to the dividend safety of the company in question.
Table 4 shows how much of both Coca-Cola's and
PepsiCo's free cash flow was paid out in dividends. Note that free
cash flow is calculated as operating cash flow, subtracted by
capital expenditures. Trailing 12-month and four-year average
figures are shown.
Table 4: Free Cash Flow Payout Ratios of Coca-Cola
Here, we see that the dividends that are currently
coming from each company are more than well-supported. With that
said, PepsiCo has the edge here as well, with just half of its free
cash flow being paid out as dividends. This low payout ratio may be
one of the reasons why PepsiCo decided to hike the dividend by 15%
this year. While PepsiCo does have the lower free cash flow payout
ratio right now, I would expect that ratio to expand once this
increased payout takes effect.
Coca-Cola also looks good here and should be able to
increase dividends going forward, as long as the company can
continue generating solid cash flows.
When it comes to the free cash flow payout ratio,
PepsiCo is the winner here.
Any Ways To Predict Dividends Going Forward?
A lot of folks would end their analysis here,
especially after looking at the free cash flow payout ratios.
However, these figures are all based on what happened in the past.
We need to find some clues as to whether the company can continue
paying steadily increasing dividends in the future.
Interest Coverage Ratio
The interest coverage ratio illustrates the size of
the company's pre-tax profits relative to the company's interest
payments. Generally speaking, the more debt a company has, the more
interest it has to pay, and the less that the company has left over
to pay out dividends. The interest coverage ratio is calculated by
dividing the company's earnings before interest and taxes (EBIT) by
the company's interest payments made over the same period of time.
Low interest coverage ratios (usually below 2) generally show that
the company is having a hard time just trying to make its interest
payments. That may signal dividend cuts or eliminations in the
future. For this reason, we like to see high interest coverage
Table 5 shows the interest coverage ratios of Coca-Cola
and PepsiCo over the last 12 months.
Table 5: Interest Coverage Ratios of Coca-Cola and
Table 5 shows us that while PepsiCo was able
to cover its interest obligations 12 times last year,
Coca-Cola's interest coverage ratio is infinite. This is because the
company received a net $71M in interest income over the last 12
months. That means that while PepsiCo is spending money on interest,
Coca-Cola is making money on it.
So, while both companies are excellent in this regard,
Coca-Cola steals the show.
Net Debt To Equity Ratio
The amount of debt that a company has can ultimately
influence the future direction of the company's dividend. Companies
that have more debt typically pay more in interest. It should also
be noted that at some point, the company's debt will need to be
repaid. While many companies are working around this by refinancing
the debt at low interest rates, this option might not be as
attractive when interest rates head back up. When the company
finally does extinguish its debt, it may have an adverse effect on
whether it can continue paying dividends.
The net debt to equity ratio can offer us some clues
as to how much of a problem debt will be when it comes to paying out
dividends. It is calculated by subtracting the company's cash
position from the company's short and long-term debts, and then
dividing that by the company's equity position. The lower this
ratio, the better it is for not only the company in question, but
for us as investors. Ratios under one are typically considered to be
Table 6: Net Debt To Equity Ratios of Coca-Cola and
Table 6 shows that while both of these companies look
very good here, Coca-Cola wins it by a nose.
Forecasted Earnings Per Share Growth
Dividend growth can be driven by a couple of
different factors. One of these factors is the expansion of the
company's payout ratio, where the company decides to pay out a
higher percentage of its earnings or free cash flow to shareholders
as dividends. However, you can only expand the payout ratio so much.
Eventually, you must have free cash flow growth in order to pay
steadily increasing dividends. And, we all know that free cash flow
growth comes from earnings growth. To get a good idea as to the
prospects of a company's future dividend payments, it may behoove us
to look at analyst projections for future earnings per share growth
over the next couple of years. Table 7 shows the forecasted earnings
per share growth rates for Coca-Cola and PepsiCo over the next
couple of years. These numbers come from the analysts at S&P Capital
Table 7: Forecasted Earnings Per Share Growth for
Coca-Cola and PepsiCo
Both Coca-Cola and PepsiCo are expected to post
solid earnings per share growth over the next couple
of years. PepsiCo, however, has slightly more favorable
Today, we have looked at a number of different
factors in order to determine the strength and sustainability of the
dividends of Coca-Cola and PepsiCo. These factors include the
dividend yield, historical dividend growth rates, payout ratios,
interest coverage ratios, net debt to equity ratios, and analyst
projections for future earnings per share growth. After giving
careful consideration to all of these factors, we can conclude that
none of the dividends being paid by either of these companies appear
to be in any danger as of this writing.
When it comes to which company has the best dividends
going forward, it's very evenly matched. Both companies currently
have the same dividend yield, which for both companies is at its
highest level in at least 2 years. They both have roughly the same
5-year dividend growth rates, with Coca-Cola having a slight edge,
especially when it comes to consistency. PepsiCo outpaced them for
2014 with a 15% increase, but as its payout ratio approaches that of
Coca-Cola, I would expect Pepsi's dividend increases to approximate
those of Coca-Cola's. As of right now, PepsiCo has the lower payout
ratios, but I expect these to rise once the dividend increase goes
into effect. PepsiCo is also expected to grow earnings per share at
a slightly higher rate of 8% versus Coca-Cola's 7%.
Coca-Cola comes out ahead of PepsiCo when it comes to
the financial condition, as they are making money on interest rather
than spending money on it. Coca-Cola is also less leveraged than
PepsiCo, as can be seen by a lower net debt to equity ratio. For
these reasons, if I had to choose one or the other, I would choose
Coca-Cola. However, I think it would be wise to own both.
Of course, before making a final decision between the
two, you must consider other items like valuation, product and
geographic diversification, and business models.