A few weeks ago I penned an article titled "Coca-Cola Yields 3% and Everyone Should Know It." Within this commentary I made the point that a stock's "current" yield is often backward looking and thus this metric can be misleading. Specifically, I indicated that while Coca-Cola (NYSE:KO) has a "current" yield of just less than 3%, a rational investor would certainly expect KO to pay out a greater sum than this in the year to come. After all the company has not only paid but also increased its dividend for 51 straight years and interrupting this streak next week just doesn't seem like Big Red's style.
Logically my points still hold weight, but it seemed that some readers got caught up in the terminology rather than the rational conclusion. This was a direct result of the future Coca-Cola dividend increase not yet being declared - something that I'll work to rectify in this article. On February 13th of 2014, PepsiCo (NYSE:PEP) announced a 15% dividend increase from $2.27 to $2.62 a share - the company's 42nd consecutive yearly payout boost. Yet the trick of it - and the reason why this is a good example - is that this new dividend will not begin until June of this year. In the interim, investor's will continue to receive the established quarterly payment of $0.5675 per share set to be payable on March 31st for shareholders of record as of March 7th.
Now if one were to go to Yahoo Finance, you would find PepsiCo listed with a 2.8% yield and an intended yield closer to 2.91%. If you were to venture over to Google Finance, you would note a similar 2.91% yield. For a third option, perhaps you frequent Dividend.com with its 3.35% dividend yield. Finally, perchance you noticed my title in which case you would see yet a different yield quoted.
So which source is correct? Well naturally it's mine, but I'll explain my reasoning shortly. More importantly, it really doesn't matter which data source is correct as that's not truly the point for most investors.
First, my explanation: as a useful annualized metric, yield would seem to indicate the amount of income one would be expected to receive within a year's time if they made a partnership decision today. You can quibble over jargon but it seems rational that one would reference yield in respect to idea of: "how much is this security going to pay" and not "what has it previously paid." It might be nice to know that milk used to sell for $1 per gallon, but that doesn't help you with your lactose purchases moving forward. Moreover, realize that even though this view sometimes requires thinking about the future, no yield is certain. Even if you annualize the most recent payment there is no absolute guarantee that the next four will be paid; events happen and no payout, whether "current" or assumed, is assured. As consistent as many of these companies are, few of them are like Wal-Mart (NYSE:WMT) - declaring all 4 dividend payments for the year at the same time.
In moving to PepsiCo's "current" yield, we know two things: 1) PEP declared a $0.5675 per share dividend payment to be paid on March 31st, 2) the company announced an increase in the dividend to $2.62 a share (or $0.655 a quarter) beginning in June. With this knowledge, it's a pretty good bet (although not certain) that the expected dividend payouts for the next 4 quarters would be along these lines: $0.5675, $0.655, $0.655, $0.655. Said differently, this would indicate a payment of $2.5325 in the coming 12 months. With a closing price around $78.10 this indicates the 3.24% yield in which the article's title designates.
Yet as interesting as this demonstration is, it's not really the important part. If you're a long-term investor - which I suspect is the case if you're focusing on growing income - you're not truly concerned about this year's dividend payment. Well you are, but really you're more concerned about this stream of income continuing into the future. So we can sit here and debate whether 2.9%, 3.3% or 3.2% is the right metric to quote for PepsiCo's "yield," but in effect these numbers are small compared to the important realization.
In the previously cited Coca-Cola article I made the point that you should think about a company's potential income stream in comparison to your applicable alternatives - higher yields, different growth rates and that sort of thing. With this article, I would like to add to this thesis by focusing on expanding one's "income thought" time horizon.
When I compare companies I don't think in terms of "current" yield. I don't think "Ok Coca-Cola has a 2.9% yield, PepsiCo has a 3.2% yield so that's a leg up for PEP." In fact, as demonstrated, depending on what data source you're viewing this could instantly lead an investor astray - if you viewed Yahoo or Google right now you might give KO the advantage. Instead, when I think about a partnership decision with PepsiCo - for instance - my income thought process is along these lines:
"Ok, PEP has effectively stated that they are going to pay 3.2% in the next 12 months based on today's prices. Due to share repurchases, inflation and the underlying pricing power of the company's dominant brands I believe the company can grow per share earnings by perhaps 6-8% a year for the intermediate-term. The dividend payout ratio is towards the upper range of where similar managements strive to keep it and consequently I do not expect dividend growth to greatly outpace per share earnings growth over the long-term. I recognize these are estimates and thus might discount my expectations with the intention to review periodically."
Using this ideology, one might suggest that PEP can grow its dividend by an average of say 7% over the next decade and discount that for uncertainty. If you aggregate those growing payouts that could mean that about half of your original capital might be returned to you in the next 10-12 years. On a shorter time horizon, perhaps you get 18% of your investment "back" in the next 5 years. This is what yield means to me.
Don't think "XYZ yields 3.2%, is that good or bad?" Instead, consider the investment on these terms: "XYZ might give me 18% of my capital back in the next 5 years, half of it back in say 12 years and perhaps all of the nominal amount in two decades, how does this compare with my alternatives for similar time horizons and how comfortable am I with those expectations?" Of course you have to adjust your calculations for the time value of money and reinvestment possibilities, but let's keep it simple. The point is this: if you have a long-term time horizon you should be thinking in terms of multi-year, if not decade, income streams and not necessarily what happens in the coming months.
Of course the trick of it is adjusting your thinking; before I have suggested that one might treat income streams as "CD-like" in that your focus is on the income generated and not necessarily the principal (and keep in mind "income generation" could also mean "income on a company-wide basis" whether the firm pays it out or not). It's not a perfect metaphor, but for those who focus on total return it is interesting to note that a growing stream of income effectively necessitates capital appreciation. In concert with this idea, Warren Buffett has previously indicated that equities are very similar to bonds with their own "equity coupons."
Whatever way you want to frame it, here's the takeaway: when you're partnering with a company you're not just partnering for the year. Instead you're likely partnering with them for a very long time. So why not think of your potential return prospects in this sense rather than a predetermined short-term frame of reference?
Disclosure: I am long KO, PEP, WMT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.