Dividend investing is a tried-and-true strategy for generating strong, steady returns in economies both good and bad. But as corporate America's slew of dividend cuts and suspensions over the past few years has demonstrated, it's not enough simply to buy a high yield. You also need to make sure those payouts are sustainable.
Let's examine how Coca-Cola (NYSE: KO ) stacks up. In this series, we consider four critical factors investors should examine in every dividend stock. We'll then tie it all together to look at whether Coca-Cola is a dividend dynamo or a disaster in the making.
First and foremost, dividend investors like a large forward yield. But if a yield gets too high, it may reflect investors' doubts about the payout's sustainability. If investors had confidence in the stock, they'd be buying it, driving up the share price and shrinking the yield.
Coca-Cola yields 2.7%, a bit higher than the S&P's 2%.
2. Payout ratio
The payout ratio might be the most important metric for judging dividend sustainability. It compares the amount of money a company paid out in dividends last year to the earnings it generated. A ratio that's too high -- say, greater than 80% of earnings -- indicates that the company may be stretching to make payouts it can't afford, even when its dividend yield doesn't seem particularly high.
Coca-Cola's payout ratio is a modest 25%.
3. Balance sheet
The best dividend payers have the financial fortitude to fund growth and respond to whatever the economy and competitors throw at them. The interest coverage ratio indicates whether a company is having trouble meeting its interest payments -- a ratio less than 5 can be a warning sign. Meanwhile, the debt-to-equity ratio is a good measure of a company's total debt burden.
Let's see how Coca-Cola stacks up next to its peers:
|PepsiCo (NYSE: PEP )||112%||10 times|
|Dr Pepper Snapple (NYSE: DPS )||116%||9 times|
|Hansen Natural (Nasdaq: HANS )||0%||N/A|
Source: S&P Capital IQ.
The three beverage stalwarts are able to carry a considerable amount of cheap debt because of their stability. Hansen Natural, the upstart maker of Monster Energy, doesn't carry any debt.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
5-Year Earnings-per-Share Growth
5-Year Dividend-per-Share Growth
|Dr Pepper Snapple||12%*||0%*|
Source: S&P Capital IQ. *3-year growth.
All four of these beverage companies display strong growth credentials. But with the exception of the outlier energy drink maker, Coca-Cola exhibits the fastest growth of its peers, and, unlike Dr Pepper, it passes a good chunk of that growth along into dividend increases.
The Foolish bottom line
With a decent yield, a modest payout ratio, a reasonable debt burden, and growth to boot, Coca-Cola exhibits a clean dividend bill of health. Though it'd be nice to see an even higher yield, I'd say the stock would qualify as a dividend dynamo. To stay up-to-speed on Coca-Cola's dividend progress, add it to your stock watchlist. If you don't have one yet, you can create a free, personalized watchlist of your favorite stocks by clicking here.