Warren Buffett is a huge fan of dividend stocks. In the billionaire investor's recent letter to Berkshire Hathaway shareholders, he called these investments the "secret sauce" behind his company's fantastic returns over the decades.
Buffett singled out Coca-Cola (KO) as a stellar example. Annual dividend payments from that one investment have grown from $75 million in 1994 to over $700 million today, and all Berkshire has had to do in that time is hold Coke shares and collect the cash. Buffett has no intention of selling the stock and interrupting that income stream, either. "We expect those checks are highly likely to grow," he told shareholders.
Investors who buy Coke today can't expect the same level of massive dividend growth over the next few decades. But the stock is still likely to deliver excellent returns from here. Let's look at some reasons why this dividend giant belongs in your portfolio.
Capital appreciation
Coke is no slouch in the growth department. Organic sales were up 11% in the third quarter, reflecting market share gains in its core on-the-go beverage niche. The company raised its outlook for the second consecutive quarter in late October.
Brands like Coke Zero are resonating with consumers, and so are the beverage titan's less traditional franchises in areas like teas and energy drinks. It isn't hard to boost sales when you dominate several global drink niches. "Our leading portfolio of brands ... positions us to win in the marketplace today while also laying the groundwork for the long term," CEO James Quincey said in a late October earnings update.
Financial wins
Coke's finances underscore why this company is such a dependable dividend payer. Operating profit margin held steady this quarter at a blazing 30% of sales after accounting for currency exchange rate swings. Operating cash flow sits at $9 billion over the last nine months, and free cash flow was $8 billion, up almost 10% from the prior-year period.
Steady growth in these areas has helped fund increasing cash returns from both dividends and stock buybacks. Coke has boosted its dividend for 60 consecutive years, with its most recent hike landing at 3%. Yet the stock's underperformance this year has kept its dividend at elevated levels. You'll get a roughly 3.4% yield if you buy the stock today.
The right price
Coke isn't nearly the steal it was back in the early '90s, but the stock isn't dramatically overvalued, either. You can buy shares for less than 6 times annual sales and 23 times earnings. Both of those metrics are near three-year lows.
The stock's performance over the short term will depend partly on unpredictable factors like economic growth rates, consumer spending patterns, and interest rates. But income investors can look past that volatility and focus on Coke's enduring competitive strengths. These include its market-leading position, high profit and cash flow, and valuable global brands.
As long as these factors keep translating into higher sales volume over time -- like they have for decades -- then you're likely to see positive returns from holding this dividend stock and simply choosing to automatically reinvest those quarterly payouts.