Answering One of Life's Persistent Questions: Coke or Pepsi?

Which of these high-quality companies is a better buy today?

May 27, 2014 at 12:55PM

High quality, household names, global brands, consistent earnings, and dividends -- Coke (NYSE:KO) and PepsiCo (NYSE:PEP) have it all, but which is a sweeter prospect for investors today?

First off, it's good to know that while both are fundamentally excellent businesses, they do not have as much in common as it appears. Coke is focused on beverages, but Pepsi could easily be seen as Frito-Lay due to its large holding in the snack business. Pepsi gets about one third of its earnings from Frito-Lay, so its success is as much about winning the snack aisle as it is about winning the Pepsi challenge.

To get an idea of the fundamental attractiveness of Coke and Pepsi in terms of delivering quality income, let's look at the metrics for safety, dividend yield, quality, and price.

For safety, let's look at the balance sheet--specifically the debt/equity ratio to see how levered the companies are. Next, we'll check the dividend payout ratios to see if there is room for those to grow. There's no sense in counting on a dividend yield if the company will have trouble paying it.

CompanyDebt/Equity Ratio


Payout Ratio

Coke 0.6 61%
Pepsi 1.1 51%

Source: Morningstar

Coke comes out ahead on balance-sheet safety with a lower degree of debt than Pepsi. Both Coke and Pepsi have safe dividend payout ratios.

Pepsi just announced a 15% hike in its dividend yield, which gives it a forward yield of 3%. Coke's forward dividend yield also sits at 3%. These aren't huge yields but the companies are seriously committed to paying them. Coke has raised its dividend for 52 consecutive years, while Pepsi has raised its dividend for 42 consecutive years. Dividends are not a hobby for Coke and Pepsi.

KO Chart

KO data by YCharts

Turning to quality metrics, operating margins and returns on equity give us a view into what kind of returns for shareholders Coke and Pepsi generate.

CompanyOperating Margin

Return on Equity

Coke 22% 26%
Pepsi 15% 30%

Source: Morningstar

Both Coke and Pepsi generate excellent returns on equity, and this bodes well for continued dividend growth. This metric illustrates that these companies can find attractive opportunities to invest in their businesses. Coke earns an edge on operating margin -- perhaps a simpler focus on beverages scales better.

All of the metrics that we have compared have been quite close to one another, and price is no different. Coke's P/E is 22 and Pepsi's P/E is 20. Both of these companies are priced above the S&P market average. Should this fact worry investors? I do not see it as a major concern to pay a slight premium to the market for an excellent business. After all, Berkshire Hathaway's Charlie Munger has three rules of investing:

  1. A great business at a fair price is superior to a fair business at a great price
  2. A great business at a fair price is superior to a fair business at a great price.
  3. A great business at a fair price is superior to a fair business at a great price.

Given that the P/E ratio of the S&P 500 is 19, paying a little bit more for either of these two companies with very high returns on equity and above-average dividend yields does not seem too worrisome.

Straightforward business models plus excellent metrics should mean that both companies have shots at delivering good total returns for investors over long-term time horizons. So which is a better buy? A case could be made for either (pun intended), but given the simplicity of its business focus on beverages, cleaner balance sheet, and better margins, the vote here goes to Coke.

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Gunnar Peterson owns shares of Berkshire Hathaway and Coca-Cola. The Motley Fool recommends Berkshire Hathaway, Coca-Cola, and PepsiCo. The Motley Fool owns shares of Berkshire Hathaway and PepsiCo and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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