Beverage behemoths Coca-Cola (KO +1.11%) and PepsiCo (PEP 0.91%) dominate the soda, water, and other drink aisles in your local grocery store. Their stocks also have a lot in common, including rich dividend histories, steady years of growth, and a recession-proof business that makes them reliable holdings for long-term investors.
But some differences set them apart, including their drinks' tastes (sorry, Coca-Cola and Pepsi do not taste the same). These subtle differences make one a better buy than the other. What are they? Open a can of your preferred soda brand, and take a look.
Valuation and growth are roughly the same
Coca-Cola and PepsiCo are similar companies, so it's tempting to jump right to valuation and think: "This one's cheaper, so it must be the better buy." But it's not that simple. For starters, the stocks are very similar in these areas:
KO PE Ratio (Forward) data by YCharts
Both stocks trade at a nearly identical price-to-earnings ratio (P/E), which values the stock based on its profits. Speaking of profits, analyst estimates call for Coca-Cola to grow earnings per share (EPS) by an average of 6% annually over the next three to five years, compared to 7% for PepsiCo.
Some minor (but important) differences
Looking at how much cash a business is generating can be very useful. Free cash flow is like the lifeblood of a business. It pays for dividends and share repurchases and helps keep the balance sheet healthy. Below, you can see that Coca-Cola is far better at getting cash out of its business than PepsiCo -- it's not even close. Coca-Cola is converting about $0.29 of every revenue dollar to cash, versus almost $0.09 for PepsiCo.
KO Free Cash Flow (% of Annual Revenues) data by YCharts
In other words, PepsiCo needs to bring in three times as much revenue to wind up with the same amount of cash as Coca-Cola! That gives Coca-Cola more money to throw around, which shows up in the dividend.
Speaking of the dividend, while both stocks have long histories of increasing their payouts, Coca-Cola also has an advantage in the dividend payout ratio:
KO Cash Dividend Payout Ratio data by YCharts
Dividends are a cash expense for a business, so PepsiCo's high payout ratio means that it can't increase the payout much further without either growing its cash profits or using cash/debt from its balance sheet. Coca-Cola's payout ratio is just 57%, which means it can keep growing the payout as long as the business keeps making this much cash.
Declaring a winner
Coca-Cola's advantages in the finer details make it the better stock to buy. Considering both stocks trade at the same valuation, I would argue that Coca-Cola is a better value because it is far more profitable. If you're a dividend investor, you should also love the longer runway Coca-Cola has for dividend growth moving forward.
That's not a slight on PepsiCo. Just like Coca-Cola, PepsiCo stock has outperformed the S&P 500 over its lifetime when you factor in dividends. However, there can only be one winner here, and Coca-Cola has just a bit more fizz for investors.
