Two years ago, I wrote a fictional story about a woman named Glon Mert, who made a fortune because of Coca-Cola (KO 1.31%). In 1920, her father bought a single share of Coca Cola stock and by 2012, it was worth $9.3 million—including reinvested dividends.
Runs like that are hard to come bye, but if you find a stock and a dividend with that kind of power, it can single-handedly produce the windfall you need for a comfortable retirement.
While it's nice to hear about how Coca Cola's past, what really matters to investors today is where the company, its stock, and its dividend are headed in the future. To help clear that picture up, I've included the most salient points that income investors need to consider before putting their hard-earned cash behind the company.
Coca Cola stock's most important metric
For income investors seeking regular and reliable dividend payments, no metric is more important than free cash flow. This represents the total amount of money that a company was actually able to put in its pocket during the year.
Contrary to what you might think, dividends are not paid from earnings — they are paid from free cash flow. And so there are two key components to watch when it comes to free cash flow: first, whether or not it is growing, and second, how much of it is being used to pay out dividends.
Over the past five years, here's what the picture looks like for the company:
As you can see, free cash flow has steadily increased every year — with 2010 being an anomaly where Coca-Cola decided to spend less money on capital expenditures during the Great Recession, and was therefore able to record more free cash flow.
Taken as a whole, the company has been able to grow free cash flow by roughly 7.5% per year since 2009. That's an important number to watch, because Coca-Cola has also tried to use roughly 60% of this cash flow to pay its dividend.
If free cash flow were to continue increasing at that rate, we'd say you should expect the dividend to grow by roughly 7.5% per year. But there's another factor to take into consideration: stock buybacks.
Since 2009, the number of Coca Cola shares outstanding has shrunk by 1.1% per year. When combined with an average 7.5% increase in free cash flow, you've got a fairly safe dividend, which is good news for income investors!
Challenges facing Coca Cola stock moving forward
Given this somewhat cheery outlook, it's important to remember that Coke's dividend is predicated on how the company performs in the real world, not on cash flow statements. And there are some serious headwinds investors need to be aware of before putting their hard-earned cash into the company.
First and foremost is the slow decline of carbonated soft drinks — CSDs or soda — in the United States and abroad. Since hitting a peak in 1998, soda consumption by Americans has fallen 20%. And just last year, overall soda volume fell 3%. There's no doubt this has to do with research pointing to the role that soda is playing in the nation's obesity epidemic. For the time being, the downtrend in soda shows no signs of stopping.
That underscores the importance of Coca-Cola's non-CSD brands. While soda sales are stagnating, the company's "healthier" brands -- Vitamin Water, Minute Maid, Honest Tea, and Powerade, to name a few -- enjoyed an 8% bump last year.
If, as an investor and consumer, you think Coca Cola can use its massive $22 billion cash hoard to continue acquiring companies that meet consumers' tastes, then this trend shouldn't worry you too much. It simply represents a shift in strategy by the company that you need to remain keenly aware of.
On the whole, Coke has one of the most valuable brands in the world. While failing soda sales could become a global problem for the company, it has other growth strategies that could succeed. With free cash flow increasing at an encouraging rate, the company's dividend looks safe for the foreseeable future, and the stock is definitely worth investigating if you're an income investor.
