The Coca-Cola Company (NYSE:KO) Yields 3% With a Reasonable Upside

The Coca-Cola Company NYSE:KO) is a staple stock for many yield-seeking investors. With decades of reliable payouts, it doesn't come as a surprise that it is the longest holding in Warren Buffett's portfolio.

Coca-Cola recently posted yet another positive quarter.

• Q2 Non-GAAP EPS of US$0.68 (US$0.12 beat)
• Revenue of US$10.1b (US$ 800m beat)
• FY2021 organic revenue growth set at 12-14%

Following the positive results, Bank of America reiterated a Buy rating, lifting the target price to US$64 against the average rating of US$60.45, giving the potential upside of 12.5%.

Meanwhile, the company continues the transition toward fewer brands, following a strategy to go from 400 to 200 brands. By cutting 200 brands, the company would only sacrifice 2% in volume sales and 1% of revenue, shifting the resources to better opportunities. Company set ambitious sustainability goals, including 100% of packaging recyclable by 2025 and net-zero carbon by 2050.

While the stock was somewhat sluggish in the last decade, lagging the consumer staples sector, its 3% dividend and sustainable innovation efforts offer a fair risk compensation.

Click the interactive chart for our full dividend analysis

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of its net income after tax. In the last year, Coca-Cola paid out 88% of its profit as dividends. However, this was an extraordinary situation where the company decided to push the payout ratio higher rather than break its stellar dividend record.

We update our data on Coca-Cola every 24 hours, so you can always get our latest analysis of its financial health here.

Dividend Volatility and Growth

Before buying a stock for its income, we want to see if the dividends have been stable in the past and if the company has a track record of maintaining its dividend. Coca-Cola has been paying dividends for a long time,59 years to be precise.

During the past 10-year period, the first annual payment was US$0.9 in 2011, compared to US$1.7 last year. This works out to be a compound annual growth rate (CAGR) of approximately 6.7% a year over that time.

Companies like this, growing their dividend at a decent rate, can be valuable over the long term if the growth rate can be maintained. Even with the soft drink sales on the decline, we believe that the global reach, the scale of production, and willingness to expand into new areas like coffee, tea, sports drinks, and even alcoholic beverages will undoubtedly help keep the growth stable. Having a world-class marketing machine does help as well.

One thing to note is the Coca-Cola's EPS are effectively flat over the past five years. Flat earnings per share are acceptable for a time, but over the long term, the purchasing power of the company's dividends could be eroded by inflation. Coca-Cola's earnings per share have barely grown, which is not ideal - perhaps this is why the company pays out the majority of its earnings to shareholders. When the rate of return on reinvestment opportunities falls below a certain minimum level, companies often elect to pay a larger dividend instead. This is why many mature companies often have larger dividend yields.

Conclusion

Few key things that the dividend investors look out for are:

• if a company's dividends are affordable
• if there is a track record of consistent payments
• if the dividend is capable of growing

We think Coca-Cola is paying out an acceptable percentage of its cash flow and profit. Earnings have not been growing, but we like that the dividend payments have been relatively consistent. While there are many better growth stories out there, it is hard to match the yield stability that Coca-Cola offers at a reasonable price.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. For instance, we've picked out 1 warning sign for Coca-Cola that investors should take into consideration.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.

Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

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