The Coca-Cola Dividend: My Prediction

The Coca-Cola dividend annual raise is one of the few traditions in corporate America that happens with generational predictable regularity. Every February since 1963, the Coca-Cola dividend has been raised. And even before that, the Coca-Cola dividend had been at least maintained every year dating back to the 1920 IPO. In recent years, Coca-Cola has gotten into the habit of raising its dividend on the third Thursday of the month. That means there is a quite high probability that the Coca-Cola Board of Directors will raise the Coca-Cola dividend this Thursday, February 18th.

The conventional wisdom is that Coca-Cola will need to relax from its ten-year record of 9.5% annual dividend growth and reduce its dividend payout ratio a bit. There is some truth to this consensus, to a point. It is factually correct to point out that Coca-Cola’s dividend has increased from the 45% to 50% in the early 2000s to 66% today. The amount of dividend growth has outstripped earnings growth by almost two percentage points over the past decade, which is problematic unless you are a business like Visa or Apple that has initiated a dividend from a low base and is actively trying to raise the payout gradually over time.

But I also think people are forgetting the lessons from Geraldine Weiss, the author of the important investment book “Dividends Don’t Lie.” Her work made a very important, and often ignored insight: When a mature company is reporting a higher than customary dividend payout ratio, it can often be a sign of undervaluation because there is often some type of understatement in the earnings that is not fully being appreciated by the investor community. As such, it creates a counterintuitive insight: The stock is cheapest when its dividend payout ratio is highest because the “e” in P/E is understated. The value of this insight is restrained to large, non-cyclical multinational firms.

In the case of the Coca-Cola dividend, critics of buy-and-hold dividend investing have been harping on the point that Coca-Cola’s reported earnings have declined from $2.08 in 2013 to $2 per share in 2015 while the dividend has simultaneously grown from $1.12 to $1.32, taking the Coca-Cola dividend from 53.85% to 66.00%. But what this ignores is that, on a constant-currency basis, the Coca-Cola earnings are somewhere around $2.15, meaning the Coca-Cola dividend would only account for 61.39% of current profits of you want to measure true earnings.

You probably read a lot about Coca-Cola’s soda volume declines, the rising dividend payout ratio, and the year-over-year reported earnings declines, but what is often neglected is this: Between 2014 and 2015, Coca-Cola increased constant currency earnings by 5%. The global inflation rate ran under 2.5%. Even though no one talks about it, the underlying reality is that Coca-Cola’s business grew at a rate double the inflation during 2015. I wish all businesses had “down” years like that.

As far as predicting the 2016 dividend, I estimate that Coca-Cola will raise the current annual payout of $1.32 per share to $1.42 per share for a growth rate of 7.57%. That amounts to a quarterly hike of the Coca-Cola dividend from $0.33 to $0.355.

The reason why I am more optimistic than those predicting a low single digit hike is because 2016 marks the first year that Coca-Cola $3 billion in projected cost cuts will start to take shape and Coca-Cola has increased its advertising budget by 12%. Companies advertise because it works, and I project that the higher than usual advertising spending will convert to around 2% or 3% in volume growth. That’s usually enough to convert into 5-6% in organic earnings per share growth, which coupled with the cost cuts, will give you earnings per share growth in the 7-8% range (and I am assuming that the Coca-Cola dividend will mirror earnings growth this year).

That’s not a bad deal. You get arguably the best company in the world at a 3% starting dividend that will grow the dividend payout somewhere in the 7-8% range over both the short and long run. As for the deviation range, it would come as a surprise to me if the quarterly Coca-Cola dividend turns out to be anything less than $0.35 or more than $0.36. In my five years of writing, it’s been remarkable to how consistent the growth of the Coca-Cola dividend has been–there’s very few other firms that offer this type of consistency, and it’s great to have a regular growing income stream that provides you the fresh cash every ninety days to do interesting things.

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