It can be tempting for investors to buy stocks with high dividend yields. That's real passive income they'll collect in the near term. And even if a company is facing complications that have crushed its stock price, that doesn't mean it'll necessarily have to cut its dividend in the near term. The company could still have plenty of cash and generate ample free cash flow to cover the dividend for a few more quarters or years.
However, this situation is commonly known as a yield trap, and it defeats the main purpose of buying a dividend stock in the first place: reliable passive income.
I think investors should avoid these high-yield traps and simply put their money in Coca-Cola (KO +0.66%), a company that pays a solid yield, has a strong business, and a terrific track record. It's what makes Coca-Cola one of the best dividend stocks around.
Image source: The Motley Fool.
Why it's one of Warren Buffett's favorite stocks
If you don't want to take my word for it, then how about Warren Buffett, a man widely viewed as one of the best investors of all time? Coca-Cola remains one of the largest holdings in Berkshire Hathaway's massive equity portfolio. Berkshire's position in Coca-Cola is now valued at over $36 billion.
Interestingly, Coca-Cola is also one of the oldest stocks in Berkshire's portfolio. Buffett and his team began buying the stock in the 1980s and completed their 400 million-share purchase in the early 1990s. Berkshire hasn't sold a share since.
A major reason Buffett and Berkshire have planned to hold Coca-Cola "forever" is the company's dividend.
"The cash dividend we received from Coke in 1994 was $75 million. By 2022, the dividend had increased to $704 million," Buffett opined in his 2022 letter to shareholders. "Growth occurred every year, just as certain as birthdays. All Charlie [Munger] and I were required to do was cash Coke's quarterly dividend checks. We expect that those checks are highly likely to grow."
Where does the dividend stand today?
Now, if you are still skeptical, then you can simply look at Coca-Cola's track record and the state of the dividend today.
Coca-Cola is rare in that it's part of an elite group of stocks called Dividend Kings. This group of companies have not only paid their dividends for at least 50 years, but also raised their dividends in each one of these years as well. In fact, Coca-Cola has paid and raised its dividend for an incredible 64 consecutive years.
NYSE: KO
Key Data Points
This means the dividend is a major reason investors buy the stock. Management would not break its epic track record with the dividend unless it had no choice, because cutting the dividend, or even leaving it stagnant, could trigger a big sell-off for the stock.
Coca-Cola also has a rock-solid 2.34% trailing 12-month dividend yield, and that's after the stock price has jumped nearly 31% higher this year. The yield used to be well over 3%.
In the second quarter of the year, Coca-Cola grew earnings per share by 17% year over year; earnings growth typically bodes well for dividend growth.
Meanwhile, the company has paid out nearly $4.6 billion in dividends to shareholders through the first six months of its fiscal year, while generating nearly $6.9 billion of free cash flow, showing that the dividend is well covered.
Investors can certainly look elsewhere and try to buy stocks with larger yields, but history tells us these usually come with trouble. My recommendation for those seeking passive income is to simply invest in Coca-Cola, then forget about it for a while and let the money roll in.
The company has one of the most enviable brands in the world, is executing its strategic plan, and is a good defensive company to own when market or economic conditions get more difficult.
