Coca-Cola (KO) is the world's largest non-alcoholic beverage company. The stock currently trades for $72.87 and has a projected yield of 2.8%.
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PepsiCo (PEP) also sells non-alcoholic beverages, but derives about 50% of its revenue from food. The stock currently trades for $65.35 and has a projected yield of 3.15%.
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Which of these beverage behemoths offers the best value for dividend investors? Let's look at the historical dividends for both companies.
| Year | Dividend | Growth |
|---|---|---|
| 2002 | $0.80 | 11.11% |
| 2003 | $0.88 | 10% |
| 2004 | $1.00 | 13.64% |
| 2005 | $1.12 | 12% |
| 2006 | $1.24 | 10.71% |
| 2007 | $1.36 | 9.68% |
| 2008 | $1.52 | 11.76% |
| 2009 | $1.64 | 7.89% |
| 2010 | $1.76 | 7.32% |
| 2011 | $1.88 | 6.82% |
| Year | Dividend | Growth |
|---|---|---|
| 2002 | $0.595 | % |
| 2003 | $0.63 | 5.88% |
| 2004 | $0.85 | 34.92% |
| 2005 | $1.01 | 18.82% |
| 2006 | $1.16 | 14.85% |
| 2007 | $1.425 | 22.84% |
| 2008 | $1.65 | 15.79% |
| 2009 | $1.775 | 7.58% |
| 2010 | $1.89 | 6.48% |
| 2011 | $2.025 | 7.14% |
In the last three years, dividend growth has been very similar for both companies. Let's look at the historical payout ratios. I will use percentage of the free cash flow instead of earnings to determine the payout ratio.
| Year | Free Cash Flow (Mil $) | Float (Mil Shares) | Payout Ratio |
|---|---|---|---|
| 2002 | $3,891 | 2,483 | 51.05% |
| 2003 | $4,644 | 2,462 | 46.65% |
| 2004 | $5,213 | 2,429 | 46.60% |
| 2005 | $5,524 | 2,393 | 48.52% |
| 2006 | $4,550 | 2,350 | 64.04% |
| 2007 | $5,502 | 2,331 | 57.62% |
| 2008 | $5,603 | 2,336 | 63.37% |
| 2009 | $6,193 | 2,329 | 61.68% |
| 2010 | $7,317 | 2,333 | 56.12% |
| 2011 | $6,554 | 2,323 | 66.63% |
| Year | Free Cash Flow (Mil $) | Float (Mil Shares) | Payout Ratio |
|---|---|---|---|
| 2002 | $3,190 | 1,789 | 33.37% |
| 2003 | $2,983 | 1,739 | 36.73% |
| 2004 | $3,667 | 1,723 | 40.08% |
| 2005 | $4,116 | 1,669 | 40.95% |
| 2006 | $4,016 | 1,686 | 48.70% |
| 2007 | $4,504 | 1,656 | 52.39% |
| 2008 | $4,553 | 1,605 | 58.16% |
| 2009 | $4,668 | 1,577 | 59.97% |
| 2010 | $5,195 | 1,614 | 58.72% |
| 2011 | $5,605 | 1,597 | 57.70% |
The payout ratio for both companies have been very similar over the last three years, around 60%. This is higher than the historical values for both companies.
Valuation
I will use the Dividend Discount Model to put an estimated value on both companies. This model assumes that the value of a company is purely the sum of all future dividends discounted back today. This is a reasonable valuation method if you are a dividend investor. The discount rate should be your required rate of return, and I will use a discount rate of 8%, which is roughly the long-term growth rate of the market as a whole. I will assume that the dividend will grow by 8% next year for both companies, and then let that growth rate decay over 20 years to a perpetual growth rate of 3%, as per the growth table below.
| Year | Coca-Cola Dividend Growth Rate | PepsiCo Dividend Growth Rate |
|---|---|---|
| 2012 | 8.51%* | 8% |
| 2013 | 7.75% | 7.75% |
| 2014 | 7.5% | 7.5% |
| 2015 | 7.25% | 7.25% |
| 2016 | 7% | 7% |
| 2017 | 6.75% | 6.75% |
| 2018 | 6.5% | 6.5% |
| 2019 | 6.25% | 6.25% |
| 2020 | 6% | 6% |
| 2021 | 5.75% | 5.75% |
| 2022 | 5.5% | 5.5% |
| 2023 | 5.25% | 5.25% |
| 2024 | 5% | 5% |
| 2025 | 4.75% | 4.75% |
| 2026 | 4.5% | 4.5% |
| 2027 | 4.25% | 4.25% |
| 2028 | 4% | 4% |
| 2029 | 3.75% | 3.75% |
| 2030 | 3.5% | 3.5% |
| 2031 | 3.25% | 3.25% |
*Coca-Cola has already announced dividends for 2012
Using these parameters, I arrive at an estimated fair value of $57.53 for Coca-Cola and $61.68 for PepsiCo. Coca-Cola is trading at a 26.67% premium to its estimated fair value while PepsiCo is trading at a 5.95% premium to its estimated fair value.
Conclusion
According to this dividend-based valuation, Coca-Cola is overvalued by over 25% while PepsiCo is trading much closer to its estimated fair value. PepsiCo is clearly the better option for dividend investors, offering a much better value than Coca-Cola.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
