Buying stocks that pay a regular and growing dividend over time can be a very rewarding investment strategy. While PepsiCo (NASDAQ:PEP) and Verizon Communications (NYSE:VZ) are not the fastest-growing companies in the world, they each have their strengths that have delivered consistent returns to shareholders. What's more, both stocks currently offer investors an above-average dividend yield, which income investors should find appealing.
But which one should you buy? We're going to review both companies' competitive position, valuation, dividends, and growth expectations to determine which is the better buy for investors today.
Stock performance, valuation, and competitive moat
Over the last decade, Pepsi stock delivered a total return (including dividends) of 201% to shareholders. On the other side, Verizon shareholders have fared somewhat better, logging a gain of 243% on their investment.
However, the winner on shareholder returns depends on which starting point you choose. Over the last five years, Pepsi comes out on top, with a total return of 72% compared to Verizon's total return of 49%. But over the past year, Verizon has returned 15%, beating Pepsi's 7.8% total return.
Pepsi usually trades at a higher price-to-earnings ratio compared to Verizon. Currently, Pepsi sports a forward P/E of 20 based on this year's earnings estimates, while Verizon trades much lower on a P/E basis, currently sitting at a forward multiple of 11.8.
Historically, the market likes to award top consumer brands with high valuations due to the high volume of sales companies like Pepsi generate every year. In addition to its well-known Pepsi label, the company also owns several snack food brands, including Doritos, Tostitos, Cheetos, and Quaker Oats, as well as beverages like Gatorade and Aquafina. The company has enormous scale and a vast distribution network around the world. These advantages have translated to gains in market share: Pepsi is either No. 1 or No. 2 in most markets worldwide.
Verizon has a competitive advantage derived from years of investing in building the broadest network of wireless coverage in the United States. This has translated to superior scale and profitability compared to Verizon's peers.
However, the main reason Verizon shares typically fetch a low P/E multiple is that the company has a massive debt burden of $113 billion while only holding $2.74 billion in cash. However, Verizon's debt is not necessarily a deal breaker. The company serves 118 million customers and that scale translates to a reliable stream of free cash flow.
Overall, I wouldn't call Verizon the better buy based on its lower valuation alone.
Both Pepsi and Verizon have a long history of distributing earnings to shareholders in the form of dividends. Pepsi currently offers investors a 3.3% dividend yield, but Verizon's low valuation translates to a higher yield of 4.46% at current stock price levels.
Verizon's higher yield looks even better considering that the wireless provider pays out 60% of its free cash flow, whereas Pepsi pays out 85% of its free cash flow. Verizon's lower payout ratio gives the company more wiggle room to sustain and increase its dividend going forward.
On the other side, Pepsi's dividend increases may slow unless the company can grow its free cash flow. It has guided for free cash flow to be roughly flat in 2019 due to restructuring efforts to improve productivity throughout the company.
Meanwhile, Verizon has a heavy debt burden which it has to pay down. So, perhaps the wireless giant's lower payout ratio doesn't look all that great at first glance. Still, Verizon did manage to increase its dividend payout over the last year while paying down $4 billion of debt.
Pepsi has momentum heading into 2019. The beverage and snack food powerhouse finished 2018 on a high note, growing organic revenue 4.6% year over year in the fourth quarter. Full-year organic revenue increased by 3.7%, while adjusted earnings per share rose 9%. These numbers are consistent with the company's past six-year compound annual growth rate. Analysts expect Pepsi to deliver earnings growth of 6.5% per year over the next five years.
The company plans to invest heavily in improving operating efficiency this year, which will weigh on near-term profitability, but should pay off over the long term in the form of higher margins and earnings growth. Management also cited a higher tax rate and gains from asset sales during 2018 that will make year-over-year comparisons more difficult in 2019. Analysts expect Pepsi to report $5.86 in adjusted earnings per share this year, representing growth of 3.5% over 2018.
Verizon also finished the year strong. The company added a net 1.2 million new wireless customers in the fourth quarter. Throughout 2018, Verizon saw customers expand their accounts with additional lines, and customers also added more devices, such as tablets and wearables, to their accounts. This is very encouraging given the competitive threat posed by T-Mobile lately, as well as stiff competition from the other major carriers, AT&T and Sprint.
Overall, Verizon grew the top line by 3.8% in 2018 and delivered robust growth of 26% in adjusted earnings per share. As for the 2019 outlook, management expects higher interest expense, higher tax rates, and other items will pressure earnings growth this year. Analysts expect Verizon to report $4.66 in adjusted earnings per share in 2019, which is slightly down from $4.71 in 2018. Over the next five years, analysts forecast earnings to grow 9.5% per year.
Give me those Doritos
This is a close call, but there's one knock against Verizon that tilts the scales in Pepsi's favor in this better-buy contest.
It seems Verizon made the classic diworsification blunder, as famed investor Peter Lynch likes to call it. In 2015, Verizon spent $4.4 billion to acquire AOL. Then, in 2017, Verizon spent $4.48 billion to buy Yahoo's core internet businesses, including Yahoo! Finance. AOL and the assets acquired from Yahoo were combined into a new subsidiary called Oath, and it hasn't paid off for Verizon shareholders.
In the fourth quarter of 2018, Verizon took a $4.6 billion impairment charge based on the poor operating performance of Oath. Essentially, the impairment is an indirect way of management admitting they overpaid for these assets.
Given Verizon's mistake, in addition to the intensely competitive wireless service industry, Pepsi earns my vote as the better buy right now.