"The greatest ideas are the simplest"
-William Golding
The goal of every income investor should be, first and foremost, to find great businesses. Lucky for us, this seemingly difficult task can be as simple as rummaging through your kitchen.
According to Beverage-Digest, The Coca-Cola Company (KO 1.50%), PepsiCo (PEP 3.62%), and Dr Pepper Snapple (DPS), collectively, account for more than 70% of all liquid refreshments sold in the U.S. -- PepsiCo also dominates the U.S. snack industry through its subsidiaries Frito-Lay and Quaker.
However, while strong brand names, powerful market positions, consistent earnings, and loyal customers make for great businesses, for one of these companies to be considered the best dividend stock, it will need to jump extra hurdles – five to be exact.
1. Cash Dividend Payout Ratio
This ratio tells us how much of the companies' cash flow is going toward paying dividends. It works two fold: first, it tells us whether or not the companies' are generating cash, and second, what percentage is going toward dividends.
Source: YCharts.
As a rule of thumb the cut-off line for a safe payout ratio is about 65%. This ensures that if one of our companies hits a speed bump they won't have to cut their dividend, and if earnings slow, the company can still safely increase its dividend.
Ultimately, I'll take Coca-Cola and PepsiCo's historical consistency over Dr Pepper's currently more attractive payout ratio.
2. Debt
Using debt can help companies grow more quickly and take advantage of opportunities. Though, when push comes to shove, paying interest on loans takes precedence over distributing dividends.
Debt is also relative, for instance, PepsiCo is about 10 times the size of Dr Pepper, so it's going to carry more debt. To level the playing field investors can use the debt-to-equity ratio. The lower the ratio, the less the company depends on debt for financing.
Coca-Cola, PepsiCo, and Dr Pepper have a debt-to-equity ratio of 1.1, 1.2, and 1.1, respectively. All very low, suggesting none of the companies should have a problem managing debt -- I'll consider round two a tie.
3. Stock price performance
Dividend stocks aren't bonds, and falling stock prices can easily wash away returns. That's why it's important to focus on total returns (dividends plus stock appreciation). While past performance doesn't always predict future returns, investors should want a stock that consistently appreciates relative to the S&P 500.
Source: YCharts.
Despite not one of three companies outperforming the S&P 500, Dr Pepper has been the strongest performer. However, it should be noted that during the financial crisis (2008 to 2009) Coca-Cola and PepsiCo performed much better than the S&P 500. Which is a good sign of stability during lean times.
4. Opportunities for growth
Considering the widespread health campaigns against soda, it's probably not surprising to hear U.S. carbonated soft drink consumption is down for the ninth straight year, according to Beverage-Digest.
However, Coca-Cola and PepsiCo's strong financial position allows them to adapt to consumer trends. For instance, Coca-Cola owns Minute Maid, Honest Tea, and Odwalla, while among PepsiCo's healthier options are Tropicana, Quaker, and Naked.
Moreover, U.S. opinions on soft drinks don't necessarily extend internationally. In fact, according to The Wall Street Journal, Coca-Cola and PepsiCo derive about "60% and 50% of their revenue from abroad, respectively."
Ultimately, while Dr Pepper is the smallest, and has potentially the greatest opportunity to steal market share, it's Coca-Cola and PepsiCo's strong international distribution channels that gives them an enormous edge.
5. Dividend growth
Every year a business doesn't increase its dividend, inflation steals some of its buying power. This is why investing in companies dedicated to consistently raising its dividend is essential.
Since 2010, Dr Pepper has grown its dividend by an incredible 170% -- though, it's unlikely the company can maintain such a savage pace. Coca-Cola and PepsiCo, on the other hand, have managed a more moderate, but still impressive, 49% and 46%, respectively.
Moreover, Coca-Cola and PepsiCo are "dividend aristocrats," and have raised their dividend for more than 25 consecutive years.
Winner
Dr Pepper Snapple has shown the most growth of late, however, the company does rely on Coca-Cola and PepsiCo licensing agreements for distribution. While this improves brand recognition, Dr Pepper won't develop the same relationships with vendors and retailers.
With that said, I think the "dividend hurdles" make it a toss-up between Coca-Cola and PepsiCo, and I favor the more diversified product offerings of PepsiCo. I think the strong market position in carbonated drinks (Pepsi/Mt. Dew) and non-carbonated drinks (Gatorade), as well as its globally strong snack business, gives PepsiCo the ability to navigate any future downturn or change in consumer preference.
