Is Coca-Cola a Great Dividend Stock?

Coca-Cola (NYSE:KO) shareholders have benefited from one of the most robust dividends in Wall Street history. The company has paid dividends for more than 100 years, and delivered its 59th consecutive annual payout hike in 2021. However, AT&T just provided the market with a grim reminder that even companies with long-standing traditions of boosting their dividends can’t guarantee that those regular increases will continue forever.

That makes this an opportune moment for investors to take a closer look at Coca-Cola and gauge its capacity for remaining a great dividend stock.

A group of friends clinking glasses of soda together while sitting at a table.

Image source: Getty Images.

The Coca-Cola dividend

Coke’s 2% dividend hike in February took its annual payout to $1.68 per share. Those who buy at the current stock price will receive a yield of about 3.1%, more than double the current S&P 500 average yield of around 1.4%.

Moreover, with more than 50 straight years of increases behind it, Coca-Cola is a Dividend King — a rare designation. That track record can give added confidence to income investors, because maintaining such a streak requires long-term balance sheet stability. For this reason, some count Coca-Cola among the safest dividend stocks in the world.

Of course, a dividend stock cannot explicitly guarantee its future payouts. Still, since abandoning a streak of that magnitude would likely cause a damaging loss of confidence in Coca-Cola stock, investors can feel a high degree of assurance that management will make continuing those payout hikes a priority.

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The competitive advantages backing the dividend

This beverage company’s portfolio goes far beyond its flagship Coke brand, and or even its sodas. The company now owns about 200 brands, including familiar names such as Minute Maid orange juice, Honest Tea, Costa Coffee, and Topo Chico mineral water.

Last year, it introduced Topo Chico hard seltzer to the Mexican and Brazilian markets and brought it to the U.S. earlier this year. This marks its first foray into the alcoholic beverage space since a brief stint in the wine business 40 years ago.

However, despite that broad portfolio, investors have to look deeper to find the company’s competitive advantages. Products such as water, tea, coffee, or juice are hardly unique. Still, Coca-Cola stands out largely through the name recognition it has built around its brands over many decades.

High spending on marketing worldwide helps ensure that this recognition continues. Additionally, the fact that it prices its products competitively fosters both recognition and loyalty.

The state of Coca-Cola’s financials

Such advantages have helped it generate the profits and free cash flow necessary to fund its dividend over the decades. Coca-Cola generated just under $8.7 billion in free cash flow in 2020 when its payout ran to just over $7 billion.

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However, the fact that the dividend now claims 81% of the company’s free cash flow is a cause for concern. Notably, that percentage remained steady compared to 2019 levels. When cash flow declined due to the pandemic, Coca-Cola management cut its outlays for property and equipment by 43%. This allowed it to keep the portion of its cash flow devoted to the dividend about the same.

Furthermore, current revenue and income trends bode poorly. In 2020, revenue fell by 11%, while non-GAAP net income dropped by 6% as the company reduced operating expenses.

Pandemic-related foodservice industry closures were largely the cause of last year’s sales decline. But Coca-Cola’s revenue growth rate has long hovered in the single-digit percentage range, and the company only forecasts a high-single-digit percentage increase in revenue for 2021 despite a predicted economic rebound this year.

Additionally, new investors will be paying a lot for relatively sluggish growth. Coca-Cola stock price has risen by only 62% over the last 10 years, compared to a gain of more than 216% for the S&P 500. Yet despite that weak performance, the stock is trading at about 33 times earnings, a ratio that exceeds long-term historical averages in the S&P 500.

KO Chart

KO data by YCharts

Should I buy it?

Although Coca-Cola generates an above-average yield, potential new investors have good reasons to be hesitant. The cost of paying its dividend already leaves Coca-Cola with little cash to invest in the business. Thus, investors should expect only modest payout hikes from here. Additionally, if the company cannot boost profits significantly in the next few years, its dividend-raising streak could be in danger. Given all that, investors should look for higher-yielding stocks that can better afford to cover their payouts.

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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