Investing in solid dividend stocks has proved time and again to be one of the simplest and most powerful strategies to obtain healthy returns from your investments over the years, while keeping risk under control. PepsiCo (NASDAQ:PEP), for example, is not only a household name, but it's also one of the most renowned dividend stocks in the market.
Let's look at PepsiCo from the perspective of dividend investors, to see whether the company still offers room for growing dividends over the coming years or if the best is already in the past for dividend investors in PepsiCo.
PepsiCo's delicious track record
PepsiCo recently turned 50 years old. It was founded in June 1965, when Pepsi-Cola CEO Don Kendall and Frito-Lay CEO Herman Lay sketched out a deal on the back of a napkin and agreed to combine the two companies. Back then, PepsiCo was making $510 million in total revenue.
Fast-forward 50 years, and PepsiCo is global giant that recorded $66.7 billion in revenue for 2014. As the business has thrived over the decades, PepsiCo stock has delivered massive gains for investors: A $100 investment in PepsiCo stock in 1965 was worth nearly $43,000 at the end of 2014. That growth represents a compound annual total shareholder return of over 13% per year, comfortably beating the S&P 500 Index over the same period.
The company has built an outstanding track record of dividend payments over time. PepsiCo has paid dividends in each and every year since 1965, and it has raised dividends over the past 43 years, including a 7% dividend increase for 2015.
It's not only about dividends; management also has an active stock-buyback policy, which increases earnings per share by reducing the amount of shares in circulation. A shrinking share count also means PepsiCo can distribute more dividends per share with the same amount of cash flow, so more buybacks today can mean more dividends tomorrow.
Over the past 10 years, PepsiCo has returned more than $60 billion to shareholders in the form of dividends and share repurchases, and management is planning to distribute $8.5 billion to $9 billion to shareholders in 2015.
At current prices, PepsiCo is paying a dividend yield in the neighborhood of 2.9%, beating the S&P 500's 2.2%. Not bad at all from this solid dividend powerhouse.
A company's history can say a lot to investors, but investment decisions should always be based on future considerations, not past performance. From a financial point of view, PepsiCo is in good shape to continue delivering consistent dividend growth over the coming years.
The company produced $10.6 billion in free cash flow during 2014, and capital expenditures absorbed approximately $2.9 billion, leaving $7.6 billion in free cash flow for PepsiCo to distribute to investors. From that money, dividends required only $3.73 billion.
Share buybacks may fluctuate over time, and they will probably depend on factors such as cash-flow growth in a particular year and management's willingness to repurchase stock at current price levels. However, dividends will most likely continue increasing over the long term.
When comparing dividends versus accounting earnings, the payout ratio is in the neighborhood of 60%. This is quite a safe figure coming from a company delivering stable and predictable earnings growth, so PepsiCo can easily sustain dividend growth in line with earnings-per-share growth in the years ahead.
No company is completely immune to changing consumer demand, but PepsiCo is doing a sound job at adapting to the trend toward healthy nutrition. The Pepsi brand currently represents less than 15% of total revenues, with carbonated drinks accounting for 25% of the sales mix. Healthier brands such as Tropicana, Quaker, Aquafina, and Gatorade are allowing PepsiCo to gain ground with health-conscious consumers, so the company is on the right side of industry trends.
Being a market leader in a mature industry, PepsiCo won't have an easy time finding growth opportunities, so investors shouldn't expect explosive performance from this giant in the short term. On the other hand, if you're looking for a solid dividend stock with enough strength to continue increasing dividends in the mid- to high single digits for years to come, then PepsiCo looks like a smart purchase.