Please ensure Javascript is enabled for purposes of website accessibility

Better Buy: Starbucks vs. PepsiCo

By Jon Quast – Jul 15, 2020 at 10:24AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

You can get more money from the stock that pays you less if you're a long-term investor.

Coffee chain Starbucks (SBUX -4.44%) is an international food-service powerhouse with over 32,000 locations. PepsiCo (PEP -0.50%) is also a global player, diversified in beverage, snack, and home-prepared food segments. And many investors are attracted to these stocks for their reliable dividends.

When picking a dividend stock, it's tempting to merely look at the dividend yield -- the last year of dividends divided by the current stock price. Currently, Starbucks' dividend yield is 2.3%, while PepsiCo's is 3%. This seems to suggest PepsiCo is the better dividend stock.

That's always been the surface-level conclusion. As the chart below shows, there's never been a moment when Starbucks offered a higher dividend yield than PepsiCo.

PEP Dividend Yield Chart

PEP Dividend Yield data by YCharts

However, fixating on the dividend yield can be misleading. Consider this: Eight years ago, Starbucks traded around $23 per share. Over the last 32 quarterly dividend payments, shareholders have collected $7.72 per share. That's a 34% total dividend return over that time. For its part, PepsiCo traded around $70 per share back then. It's paid $23.66 per share over the last 32 quarterly payouts. That's also a 34% total dividend return.

This article will demonstrate how this is possible. And it will explain why Starbucks, not PepsiCo, is the better dividend stock to buy today.

A soft drink is poured into a glass against a black background.

Image source: Getty Images.

Pepsi's pandemic quarter

PepsiCo just reported results for the second quarter of 2020 that perfectly typify a macro view of the company. Organic revenue for its North American beverage segment was down 7%. Because of the coronavirus, consumers purchased fewer carbonated drinks at restaurants and convenience stores. However, organic revenue at its Quaker Foods segment surged 23% compared to 2019 as consumers prepared more food at home. The net result was organic revenue fell 0.3% in Q2.

This is the advantage of PepsiCo: It's a diversified company that owns 23 brands with annual sales over $1 billion. One can always count on at least something doing well. But the company doesn't currently boast impressive revenue growth. Consider for 2014, it generated $66.7 billion in net revenue. Five years later in 2019, it generated $67.2 billion -- up less than 1% over that span.

PepsiCo is a Dividend Aristocrat, having raised its dividend every year for 47 consecutive years. That's elite. However, the company is somewhat limited in how much it can raise the dividend with each passing year. Lacking top-line growth, it's challenging to substantially grow the bottom line -- where dividends come from. And its payout ratio is already high at 74%.

Over the last five years, PepsiCo has raised its dividend by an average of 8% per year. And the stock price has risen at roughly the same pace, keeping the dividend yield more or less constant. The annual raises and 3% yield are nothing to sneeze at. Yet Starbucks is able to raise its dividend at a faster pace, offering a superior dividend return over an extended period of time.

A row of stacked coins, with each stack progressively taller.

Image source: Getty Images.

Starbucks' superior earnings growth

Starbucks hasn't fared as well as PepsiCo during the coronavirus pandemic. The company isn't expected to report earnings until later in the month, but guidance was awful. It expects COVID-19 to reduce third-quarter revenue by at least $3 billion, resulting in a net loss per share of $0.64 to $0.79.

As abysmal as that sounds, Starbucks is rolling with the punches. It's rolling out new smaller-footprint stores in U.S. urban areas and China designed to be to-go operations, mitigating the future liability of owning too many dining rooms. The company is also very capable of financially enduring the present coronavirus challenge, and expects to report a full-year 2020 profit. 

Moving past the coronavirus, Starbucks has more growth levers to pull. For example, China's population is four times the U.S. population, yet the company operates half as many restaurants there. It plans to open 500 new Chinese locations this year alone, and it wouldn't be crazy to think it can still double the 4,400 locations it currently operates in the country.

As Starbucks continues to grow revenue, it's able to more easily expand its bottom line. This provides plenty of room to grow the dividend. Over the last five years, Starbucks raised the payout by an average of 21% annually. Its dividend yield may not be as high as PepsiCo. But for patient investors, Starbucks' dividend outperforms over time. 

PEP Normalized Diluted EPS (TTM) Chart

PEP Normalized Diluted EPS (TTM) data by YCharts

The better buy

To be clear, I'm not suggesting PepsiCo's dividend is in any sort of danger. To the contrary, I believe it's one of the better Dividend Aristocrats. But Starbucks gives today's investors top-line growth opportunity. This not only should provide a superior overall stock return compared to PepsiCo, but also should allow bigger dividend payouts in the long run.

Jon Quast owns shares of Starbucks. The Motley Fool owns shares of and recommends Starbucks. The Motley Fool has a disclosure policy.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.