Investing in dividend stocks can be an excellent way to generate passive income. Companies that pay dividends tend to be more mature, profit-generating operations that have established lines of business and a loyal base of customers. Their ability to regularly pay out excess profits in the form of dividends suggests they are a less risky investment than the average stock.
One such company with a long history of profit generation and dividend payouts is Coca-Cola (KO +0.00%). The company is really good at generating cash, maintaining excellent profit margins, and the stock offers a generous dividend yield of 3%. Even better, Coca-Cola stock happens to be selling at a reasonable price right now.
Image source: Getty Images.
Coca-Cola has a solid foundation for dividend growth
Coca-Cola has a large portfolio of beverage products that have been quenching people's thirst for generations. Its collection of globally known brands give the company a competitive advantage against newcomers.
That can partly explain how Coca-Cola manages to increase free cash flow over the long run. Even in the operationally challenged fiscal 2020, Coca-Cola still generated $11.5 billion in free cash flow. The metric is important because free cash flow is where dividends tend to be paid from. Other uses of free cash flow include buying back stock, reinvesting in the business, paying back debt, and buying short-term investments. Therefore, if free cash flow increases, there is more money available for dividends.
Coca-Cola can generate lots of cash because it operates with such high profit margins. Between fiscal 2011 and fiscal 2020, Coca-Cola averaged a pre-tax income percentage of 24.2%. That is a good figure by itself, but it looks even better when you compare it with rival PepsiCo's (PEP 1.07%) 13.3% in the same metric. Admittedly, it is not an apples-to-apples comparison because PepsiCo has other business segments in addition to beverages, but it does highlight Coca-Cola's superior performance.
Coca-Cola did take a hit during the coronavirus pandemic as many of the businesses (like theaters, stadiums, restaurants, and theme parks) it has agreements to provide beverages for were temporarily shut down, only served carry-out, or operated at reduced capacities. The company has a higher market share in away-from-home channels, so these closures hurt sales of its beverages, and the company's revenue decreased by 11.4% in 2020. With many economies at least partially reopening in 2021, revenue should rebound nicely. Coca-Cola should get a tailwind from folks feeling more comfortable about leaving their homes.
Should I buy Coca-Cola stock right now?
Data by YCharts.
Coca-Cola has a long history of increasing dividends. As the chart above illustrates, the dividend per share has climbed from less than $0.25 per share in 1990 to $1.64 per share in 2020. Considering the beverage giant continues to increase cash flow and operate at healthy profit margins, there is no reason this trend won't continue.
Moreover, Coca-Cola stock is trading at a favorable price-to-free cash flow ratio of 20, near the lowest it has sold for in the last decade. A solid and growing dividend, increasing cash flows, and a favorable valuation make Coca-Cola an outstanding dividend stock to buy right now.
