Finding a good dividend involves more than just screening for high yields and long track records of annual payout raises. Many blue chip businesses would show up in that search, but only a few of these stocks will end up generating the type of market-thumping returns that income investors are reaching for.
That fact shines through when stacking up two Dow giants, Coca-Cola (KO 0.25%) and Home Depot (HD -0.77%). While the beverage titan has plenty of attractive investment qualities, Home Depot looks like the better dividend stock right now.
Sure, Coca-Cola pays a higher yield today, at over 3% compared with Home Depot's 2%. But that gap is mainly due to investors' judgments about the two companies diverging growth outlooks. Consumers are more focused on home improvements thanks to pandemic-related changes to shopping and work habits. These shifts have moved against Coke by severely limiting people's mobility and densely attended events like concerts and sports.
Those limitations won't last forever (Coke believes a full recovery might take less than two years). Yet it still seems likely that Home Depot will have more resources it can direct toward dividend boosts at least through 2021. The company last reported double-digit gains in both customer traffic and average spending per visit on the way to adding $8 billion of additional revenue to its sales base. Coke, in contrast, saw sales volumes drop 16% in the most recent quarter .
Home Depot was a more generous dividend payer even before the pandemic began supporting its finances in early 2020. Its last annual hike was 10%, compared with Coke's 2.5%. Home Depot also targets returning over 50% of yearly earnings to shareholders as dividends. Rival Lowe's (LOW -0.29%), on the other hand, targets a payout ratio of 35%.
That more-aggressive posture does come with extra risks. Home Depot paused payout hikes during the worst of the housing crisis in 2009 and 2010 while Lowe's continued its modest increases. That's why the chain doesn't qualify as a Dividend Aristocrat today, while Coca-Cola easily meets those requirements.
Perhaps the best reason to love Home Depot as a dividend stock is its financial efficiency. Under CEO Craig Menear, the company has put together a stellar track record of spending that positioned it well for the current multichannel selling environment while aggressively buying back stock.
The combination of these trends allowed return on invested capital to hover near 40%. That's well ahead of Coke's 14% figure and good enough to keep Home Depot near the top of the entire market on that key financial metric.
Of course, these performance gaps aren't a secret on Wall Street, and that fact helps explain why Home Depot shares have trounced the market in 2020 while Coke's are lagging. The beverage giant might also attract investors who prefer to purchase excellent businesses that appear to be going through temporary slumps.
Yet Home Depot has earned its premium valuation through a wide range of selling conditions. Those wins point to some enduring advantages in this business that should continue rewarding income investors over the next five or more years.