Dividend Report Card: Coca-Cola

In this series, we analyze financial metrics to begin answering the following questions about a company's dividend:

1. Over time, has this company steadily increased its payouts?
2. How sustainable is the dividend?
3. Does the company have room to further increase the dividend?

The Dividend Report Card wasn't designed as a buy or sell signal but rather as a tool to gauge the health of a company's dividend. For a full explanation of each category, click here for a tutorial.

Today's pupil is Coca-Cola (NYSE: KO), which posts a 3% yield. In his most recent shareholder letter, Warren Buffett said he expected Berkshire Hathaway's dividend income from its investment in Coca-Cola would double within 10 years -- implying a roughly 7.2% annualized dividend growth rate. Let's see if that's a reasonable expectation.

Dividend history

Source: Capital IQ.

Coca-Cola has an enviable dividend track record, having increased its dividend for 49 consecutive years and it's paid its dividend since 1893.

Now, technically, a dividend growth rate of less than 10% but more than 7% gets 4 out of 5, but based on its rich history, we'll give Coca-Cola the benefit of rounding, so it scores a 5 of 5 in this category.

Sustainability

Source: Capital IQ, a division of Standard & Poor's, as of March 24.

In addition to being a consistent free cash flow generator, Coca-Cola has a very solid balance sheet, covering each dollar in interest payments with $12.30 in operating profits. Morningstar gives Coca-Cola a high credit rating of "AA-" and it's easy to see why.

It's worth noting that I used "normalized" earnings to calculate EPS and FCF payout ratios -- this was done because of Coca-Cola's large exceptional gain realised from the Coca-Cola Enterprises acquisition. The adjustment was also used for the sustainable growth rate in the next section.

Even without that nearly $5 billion one-time gain, Coca-Cola's earnings and free cash cover are still very good. In short, the dividend looks quite sustainable.

Growth

According to Capital IQ, the median analyst estimate for long-term EPS growth is 10%. Even if Coca-Cola falls short of those expectations, it does have some room to increase its payout ratios to fuel dividend growth.

In short, it's easy to see why Buffett thinks Coca-Cola's dividend can double over the next 10 years -- a 7.2% compounded growth rate is certainly achievable.

Competitors
An "ungraded" section of the dividend report card is to see how a stock's current yield stacks up against that of direct competitors. If it's too high relative to competitors' yields, the board could be tempted to slow the growth rate, or vice versa, to bring it more in line with the industry average.

Compared to this group, Coca-Cola's current yield at 3% seems to be right at home -- not too high, not too low.

Pencils down!
With all the numbers in, here's how Coca-Cola's dividend scored:

Surprise, surprise -- Buffett looks to be spot-on with his estimate that Coca-Cola's dividend could double in the next 10 years. Investors will want to keep an eye on free cash flow coverage in the coming years, but the dividend looks quite healthy.

Have you added Coca-Cola to your Watchlist? Well, what are you waiting for?