Dividend stocks can be a profitable source of income and capital appreciation for retirees. However, investors must be careful to invest in the businesses best positioned to win today and tomorrow, rather than simply placing blind faith in the champions of old.
The fallen king
There was a time when Coca Cola (KO -0.25%) was regarded as the prototypical retirement stock. It had a powerful brand, unequaled global distribution system, stable cash flows, and a steadily growing dividend. All of that remains true today. What's changed, however, is that Coca Cola's growth no longer seems so assured.
U.S. soda sales have been in a state of decline for a decade, and now that trend may go global; Coca Cola volume rose less than 1% in 2014 on a worldwide basis, with international volume growth just barely offsetting a further decline in U.S. volume. Sales of diet sodas are faring even worse, with global Diet Coke volume falling 7% in the most recent quarter, as concerns over artificial sweeteners appear to be taking a toll.
Coca Cola is attempting to buy growth by partnering with smaller, faster-growing businesses like Monster Beverages and Keurig Green Mountain. However, these investments are too small to move the needle in terms of Coca Cola's overall revenue base. And the Keurig Green Mountain investment is off to a particularly inauspicious start, with shares having since lost about a third of their value from the price Coca Cola paid when it first took a 10% stake in the company in early 2014.
I should mention that Coca Cola does have an excellent history of returning capital to shareholders, which it continues to do via dividends and stock repurchases. I should also note that Coke's dividend is not currently in danger of being cut, and the company recently raised its dividend by 8% on top of a 9% increase in 2014.
However, should the lumbering soda giant be unable to recharge its revenue and profit growth in the years ahead, continued dividend increases of this size will prove unsustainable.
Even worse would be if investors begin to view Coca Cola as a declining business, which could lead to a sharp contraction in its stock's P/E multiple. In that scenario, Coke's price would fall as investors reduce the price (P) they're willing to pay for Coke's earnings (E) as they lose confidence in the growth assumptions currently priced into Coke's shares. And if Coke's earnings actually do go into a prolonged state of decline, we could see a lower multiple on top of a lower earnings base, which would likely result in significant losses for investors.
Source: Wal-Mart
The emperor has no clothes
Wal-Mart Stores (WMT -2.01%) has ruled over the retail landscape for decades, creating fortunes along the way for early shareholders. And thanks to its strong cash flow generation and rising dividend payments, its stock has become a common recommendation for retirees. But Wal-Mart recently saw its market capitalization surpassed by e-commerce juggernaut Amazon (AMZN 0.98%), and I believe that's a powerful sign of what's to come.
Wal-Mart came to dominance through an unbeatable combination of low prices, a wide selection of goods, and a convenient shopping experience. Now, however, Amazon is positioned to overtake the once unassailable Wal-Mart on each of those fronts.
Part of the problem is that Wal-Mart's management is far too confident regarding the benefits that its massive store base provides relative to online rivals. CEO Doug McMillon had this to say on the subject in his second-quarter earnings call remarks:
Just as it was in 1996, we will win the future of retail if we make the right choices as a business. We have a strong point of view on what that future will look like ... We believe the winners in retail will be those who can bring together the best of the offline world with the best of online to serve customers however they want to shop, and we believe Wal-Mart has unique competitive advantages in this race.
That all sounds great in theory, but the reality is that the world has changed dramatically since 1996. The Internet has completely disrupted huge swaths of the retail industry, and many of the core components of Wal-Mart's business model are now more of a hindrance than an advantage. For example, the brick and mortar behemoth's more than 11,000 stores and 2.2 million employees place Wal-Mart at a structural cost disadvantage to Amazon and its primarily Internet-based operations -- one that will make it increasingly difficult for Wal-Mart to consistently and sustainably match Amazon's prices.
Worse still, Wal-Mart's notoriously low pay for employees has made it a target for labor and activist groups, while its recent attempts to boost worker compensation has dented its profit margins. Wal-Mart is stuck between a rock and a hard place, and will likely need to choose between lower levels of profitability -- should it continue to raise salaries in an attempt to improve its infamously poor customer service -- or lower sales (should management decide to raise prices to offset lower margins). Neither one of those scenarios is good, and retirees may be best served by simply staying well clear of Wal-Mart's shares.
