It isn't too often that you have a chance to purchase a high-performing business that also pays an elevated dividend yield. Investors usually have to choose between one or the other of these attractive characteristics. But that might not be the case facing Coca-Cola (NYSE: KO) investors right now.
The beverage giant dominates its global industry and yet its yield is sitting close to a post-pandemic high thanks to the combination of a rising payout and the stock's weak performance in 2023.
Sure, it's generally true that higher yields often come with some compromises, either around growth prospects or earnings potential. With that risk in mind, let's look at the main reasons why Coke pays more than peers like PepsiCo(NASDAQ: PEP), and whether income investors should still like the stock today.
Growth matters
Dividend growth is ultimately funded by sales growth and cash flow, and both metrics are slowing down in Coca-Cola's case. Organic sales growth landed at a bubbly 12% in fiscal 2023, but almost all that improvement came from rising prices. Volume rose just 2% for the year.
Price hikes in 2024 won't provide nearly the same lift that they have in the past few quarters. That's mainly because inflation has slowed, but also partly because consumers are becoming more price sensitive. Coke is also facing a slower consumer spending environment. As a result, management forecast that sales growth will be cut roughly in half in 2024, down to a range of about 6% to 7%.
The short-term outlook is weak when it comes to cash flow as well. Coke is expecting to generate $9.2 billion of free cash in 2024 to mark a 5% decline following last year's 2% uptick. The dividend can easily continue climbing through such a drop. Yet investors should brace for more modest dividend increases ahead in the next year or so.
That high yield
Investors are being compensated well for taking on these elevated risks around Coke's short-term financial trends. The stock is valued at 5.7 times sales compared to its pandemic high of closer to 7 times sales. Its dividend yield is 3.1% as of this writing, compared to the 2.9% you'd get from owning Pepsi or the 2.7% rate available from Keurig Dr Pepper shares.
Owning $5,000 of Coke's shares would deliver roughly $150 of passive income in year one. The company has raised its payout in each of the last 61 years as well, so you can feel highly confident that the dividend will keep rising over the coming decade even if sales trends remain muted.
If you're looking for head-turning growth, then Coca-Cola stock might not be for you. Peer PepsiCo warned investors last month that consumer spending trends were slowing down to the pre-pandemic normal and that this shift is combining with falling inflation to pressure sales for the foreseeable future. Coke is facing many of the same challenges, and that helps explain why the stock underperformed the Dow Jones Industrial Average in the last year. Most Wall Street pros are expecting sales to be flat this year before rising by about 5% in 2025.
Coke can do a lot with even modest sales growth, though, especially given that its operating profit margin is 28% of sales, or about twice PepsiCo's rate. Patient investors can get exposure to that industry-leading financial strength at a discount today while they wait for demand trends to rebound. In the meantime, consider electing to have Coke's quarterly dividend payments automatically reinvest into more shares, amplifying your returns over the long term.
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Demitri Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
