Diageo vs. PepsiCo: Which Stock's Dividend Dominates?

Dividend stocks outperform non-dividend-paying stocks over the long run. It happens in good markets and bad, and the benefit of dividends can be quite striking -- dividend payments have made up about 40% of the market's average annual return from 1936 to the present day.

But few of us can invest in every single dividend-paying stock on the market, and even if we could, we're likely to find better gains by being selective. Today, two international beverage companies -- one a bit harder than the other -- will square off in a head-to-head battle to determine which offers a better dividend for your portfolio.

Tale of the tape
Formed in 1997 from the merger of Grand Metropolitan and Guinness, U.K. Based Diageo (DEO -1.48%) is the world's largest producer of spirits and is also one of the world's leading beer and wine producers. It owns some of the best-selling premium alcoholic brands, including Baileys, Johnnie Walker, Smirnoff, Captain Morgan, and Guinness. The company has offices in more than 80 countries, and it sells and markets products in over 180 countries around the world. Diageo was once as deeply enmeshed in the food industry as its competitor in this dividend contest, but between 2000 and 2002, Diageo divested its food businesses to focus entirely on alcoholic beverages. The company also acquired Seagram's spirits and wine business to augment its products portfolio in 2001.

In 1965, Pepsi-Cola and Frito-Lay merged to form PepsiCo (PEP -0.41%), now the world's second-largest nonalcoholic beverage manufacturer. Headquartered in Purchase, N.Y., Pepsi owns a portfolio of more than 22 brands, which in addition to its eponymous cola include Mountain Dew, SoBe, and Aquafina, which are sold in over 200 countries or territories around the world. Since joining with Frito-Lay's deep roster of snack brands, PepsiCo's added a wide range of food and beverages brands; it bought Tropicana in 1998 and acquired Quaker Oats in 2001. However, PepsiCo, like Diageo, spun off its fast food holdings in 1997 to focus more on snack foods and sodas.

Source: Morningstar and YCharts.
*Free cash flow margin is free cash flow divided by revenue for the trailing 12 months.

Round one: endurance (dividend-paying streak)
Diageo has paid uninterrupted dividends at least twice every year since initiating payment in 1998 shortly after the completion of its merger. That's a respectable length of time, but it fell short compared to PepsiCo, which began paying dividends in 1965, and has been paying ever since. A 46-year dividend streak lets PepsiCo win the endurance crown without breaking a sweat. Unfortunately, hard data on the dividend history of either of these companies before they merged and adopted their current identities is nearly impossible to find, but it may be the case that Guinness or Grand Metropolitan's dividend streak is longer than Pepsi's. Without verification on that matter, this round goes to Pepsi.

Winner: PepsiCo, 1-0.

Round two: stability (dividend-raising streak)
PepsiCo's 41-year dividend- streak of dividend boosts is much longer than Diageo's dividend's existence. That's another easy win for PepsiCo, as Diageo only started raising its dividends in 2000, and avoided a payout increase in 2009 as a result of the global financial crisis.

Winner: PepsiCo, 2-0.

Round three: power (dividend yield)
Some dividends are enticing, but others are merely tokens that barely affect an investor's decision. Have our two companies sustained strong yields over time? Let's take a look:

DEO Dividend Yield (TTM) data by YCharts

Winner: Diageo, 1-2.

Round four: strength (recent dividend growth)
A stock's yield can stay high without much effort if its share price doesn't budge, so let's take a look at the growth in payouts over the past five years.

DEO Dividend data by YCharts

The erratic biannual payout system can't change the evidence of Diageo's commitment to higher payouts, as the trough of its zigzag has remained higher than Pepsi's step-like growth throughout the last five years.

Winner: Diageo, 2-2.

Round five: flexibility (free cash flow payout ratio)
A company that pays out too much of its free cash flow in dividends could be at risk of a cutback, particularly if business weakens. We want to see sustainable payouts, so lower is better:

DEO Common Stock Dividend Payout Ratio (TTM) data by YCharts

YCharts often has a problem displaying this result for foreign companies, but if we simply look at Diageo's cash flow statements (or use Morningstar as a shortcut), we can see that its free cash flow payout ratio is very high, and for the past four quarters the company's dividends amounted to 88% of its free cash flow.

Winner: PepsiCo, 3-2.

Bonus round: opportunities and threats
PepsiCo may have won the best-of-five on the basis of its history, but investors should never base their decisions on past performance alone. Tomorrow might bring a far different business environment, so it's important to also examine each company's potential, whether it happens to be nearly boundless or constrained too tightly for growth.

Diageo opportunities

• Diageo has expanded its line of flavored vodkas and low-calorie liquors, which appeal to women.
• The company is less exposed to the fluctuating grape prices than other wine producers.
• It recently made a $1.6 billion investment to ramp up whiskey production in Scotland.
• Diageo's Russian revenue has grown by double digit percentages for the past few quarters.
• Diageo acquired India's largest spirit-manufacturer, United Spirits, for $521 million.

PepsiCo opportunities

• PepsiCo continues to expand aggressively in emerging markets.
• The company is the U.S. soft drink and savory snack market leader.
• PepsiCo's balance between snacks and soft drinks offers multiple avenues for growth.
• A potential merger with Mondelez (MDLZ -0.71%) would make PepsiCo an unrivaled packaged-food company.

Diageo threats

• Pernod Ricard's whiskeys are outperforming Diageo's top brands.
• Emerging markets have recently become a drag on Diageo's growth.

PepsiCo threats

• Growing health concerns and negative publicity are stigmatizing soft drinks.
• Similar issues haunt the snacks market -- PepsiCo is not known for healthy products.

One dividend to rule them all
In this writer's humble opinion, it seems that PepsiCo has a better shot at long-term outperformance, thanks to its aggressive expansion plans, diversified portfolio and a stable dividend history -- the company should be able to weather and adapt to any consumer health backlash. Diageo's straightforward focus has benefited from pro-liquor trends in the global marketplace, but reliance on this industry might hold down real growth over the long run. You might disagree, and if so, you're encouraged to share your viewpoint in the comments below. No dividend is completely perfect, but some are bound to produce better results than others. Keep your eyes open -- you never know where you might find the next great dividend stock!