Many companies talk about the ways they enhance shareholder value by returning cash via dividends or stock buybacks, but investors shouldn't just take the company's word for it.

In this series, we'll investigate how companies spent free cash flow over the past five years. By doing so, we hope to gain insight into whether the company's management might be good stewards of shareholder capital.

Today, we'll take a look at beverage giant Coca-Cola (NYSE: KO).

How does Coke spend free cash?
First, let's examine how much free cash flow the company has generated in each of the last five years, and how much of that has gone to dividends and buybacks.

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Source: Capital IQ as of June 29, 2011. Free cash flow = net income + depreciation - capital expenditures - change in noncash working capital.

Even though Coca-Cola increased its buyback spending in 2010, cash dividends remain Coca-Cola's primary way of returning shareholder cash. During this period, Coca-Cola raised its dividend at a 9.5% annualized growth rate.

Is the dividend covered?
Next, let's see how much of the company's free cash flow has gone to dividends.

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

Coca-Cola had a meaningful one-time gain in 2010, which provided a temporary boost to net income and free cash flow. This helps explain the sharp drop in the free cash flow payout ratio. Investors should expect the "normalized" ratio to be somewhere between 60%-70%.

That's still quite good, of course, and it shows that Coca-Cola's dividend is well-covered by free cash flow.

Are they good investors?
Companies are notoriously bad investors in their own stock. Consider that in 2007, when the market was hitting record highs, S&P 500 companies bought back a record $589 billion versus $246 billion in cash dividends; in 2009, when the market was around its nadir, buybacks hit record lows.

Is Coca-Cola an exception?

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Source: Capital IQ.

Coca-Cola has made fairly consistent use of buybacks, but it doesn't appear to have aggressively bought back its stock in late 2008 and early 2009, when it was trading at what was, in hindsight, a great long-term value. Still, it seems to have repurchased shares at good-to-fair prices over this period.

Competitors
How does Coca-Cola's use of free cash flow stack up against some of its major competitors in the last four quarters?

Company

Free Cash Flow

Share Buybacks

Dividends

Coca-Cola $10,624 $4,088 $4,118
PepsiCo (NYSE: PEP) $4,634 $4,604 $3,035
Kraft Foods (NYSE: KFT) $645 $0 $2,029
Dr Pepper Snapple Group (NYSE: DPS) $620 $1,011 $212

Source: Capital IQ. All figures in millions as based on trailing-12-month data.

The biggest difference among Coca-Cola, PepsiCo, and Dr Pepper Snapple Group is that Coca-Cola seems to favor returning shareholder cash via dividends. With the exception of 2009, for example, PepsiCo has bought back more of its stock each year since 2006 than it's paid in dividends.

Foolish bottom line
Unsurprisingly, Coca-Cola seems to be making good use of its free cash flow, and its 49-year streak of consecutive dividend increases should safely continue.

Its interest in buybacks has increased recently, so dividend-focused investors will want to keep an eye on how Coca-Cola's balancing dividends and buybacks in relation to free cash flow generation.