Why Dividend Growth Investing Works

The company is bolstering its e-Commerce division by acquiring talented workers through buying out smaller tech businesses. Recent acquisitions include Adchemy, Stylr, and Luvocracy. Wal-Mart does not expect growth to slow for its e-Commerce division anytime soon. The company is expecting e-Commerce sales to grow by 25% over full fiscal 2015.

Expected Shareholder Return

Shareholders of Wal-Mart can expect solid returns going forward. The company currently has a dividend yield of over 2.5%, and repurchases about 2.5% of its shares outstanding per year. Shareholders of Wal-Mart can expect a return of about 5% from dividends and share repurchases alone.

The company has managed to grow its total selling square footage by about 3% a year over the last several years. If comparable store sales remain constant, this will add another 3% to shareholder return per year.

Wal-Mart is expected to deliver flat comparable store sales next quarter. As the company continues to expand overseas and implement improvements domestically, its same store sales should rise. If the company achieves comparable store sales increases from 0% to 3% per year, shareholders of Wal-Mart can expect a total return of 8% to 11% from dividends and share repurchases (5%), store count and selling square footage growth (3%), and comparable store sales increases (0% to 3%).

Coca-Cola: Global Beverage Leader

Coca-Cola is the world’s largest seller of single serve beverages. The company has a market capitalization of over $182 billion and 17 brands that sell over $1 billion per a year in sales. Surprisingly, 11 of the company’s 17 $1 billion brands are not sodas; they are non-carbonated drinks like Minute Maid, Powerade, Dasani, Vitamin Water and Simply. Coca-Cola has done especially well expanding into the juice market. Amazingly, the company has captured 33% of global juice growth since 2007.

Current Results

Coca-Cola posted favorable 2nd quarter results. Constant currency adjusted revenue increased 3% for the company with worldwide volume growing 3%. The company’s sparkling (carbonated) volume was up 2% globally, with a 1% volume increase of Coca-Cola in the US. The volume increase in the US was somewhat unexpected as soda volume has been declining in the US and other developed markets in recent years as consumer preferences change away from sodas.

Coca-Cola grew sparkling (carbonated) beverage volume 2% globally by heavily advertising through its sponsorship of the FIFA world cup. Sprite posted the strongest volume gains, with a 6% increase. Fanta volume grew 2%, and Coca-Cola volume was up 1% globally. Coca-Cola operations are split geographically.

Coca-Cola is doing very well in the Asia/Pacific region. Sparkling volume increased 10% in China for the quarter on strength from the Share a Coke campaign. China is perhaps the company’s most important emerging market; double digit growth in the country is a success for Coca-Cola.

Asia Pacific volume grew 8% for the quarter overall. Coca-Cola increased sparkling volume 9% in the region, and still volume 7%. The company’s ability to grow its flagship sparkling brands in China point to a long growth runway in the region for Coca-Cola.

The company’s other bright spot is the developing markets of Eurasia and Africa. Coca-Cola grew volume 5% in this region for its most recent quarter. Gains came from deeper market penetration brought on by the FIFA world cup advertising campaign.

Sparkling beverages grew a modest 3%, while still beverages were up 12% in the quarter. Coca-Cola’s impressive still (non-carbonated) beverage growth in the Eurasia/Africa region shows the company continues to compete successfully in the non-carbonated beverage industry.

Coca-Cola’s European segment posted mixed results for the 2nd quarter. Northwestern Europe, Germany, and the Iberian Peninsula (Spain, Portugal) posted small volume growth. Central and Southern Europe volume declined 4% for the quarter.

As a whole, Coca-Cola’s European segment posted no volume growth for the second quarter. Weak European results are juxtaposed against the company’s strong emerging market growth. Coca-Cola is having a difficult time growing sales in the stagnant developed European economy.

Like Europe, Latin America’s volume was flat for the quarter. The company’s South American business units performed well, growing volume 8%. Volume in Brazil did not grow due to strong competition. Volume in Mexico declined 3% due to the company’s institution of an excise tax.

Despite these setbacks, still (non-carbonated) volume increased 3% for Latin America, while sparkling beverage volume declined 1%. Volume growth will likely rebound as the effects of the excise tax will not impact long-term growth.

Coca-Cola gained market share in the sparkling category for the 2nd quarter of 2014 in North America. Despite gaining market share, sparkling volume was flat. Still beverage volume increased 1%. Coca-Cola’s still portfolio has either held or grown market share for 17 consecutive quarters.

Not only does Coca-Cola North American have dominant sparkling brands, they have dominant still brands as well. The future for Coca-Cola’s North American growth lies in its ability to expand its current still brands and acquire new brands.

Coca-Cola’s Stake in Monster

Coca-Cola recently announced it will acquire a 16.7% stake in Monster, the fast growing energy beverage business for $2.15 billion, or about $77 per share of Monster. The deal is expected to close at the end of 2014 or the beginning of 2015. Coca-Cola will finance the transaction with excess cash.

The transaction is not a simple equity purchase; the companies are transferring brands to better align each company with its area of expertise. Coca-Cola will transfer its worldwide energy brands which include NOS, Full Throttle, Burn, Mother, Power Play, and Relentless to Monster.

In return, Monster will transfer Coca-Cola ownership of Hansen’s Natural Sodas, Peace Tea, Hubert’s Lemonade, and Hansen’s Juice Products. The deal will also make Coca-Cola Monster’s preferred distribution partner worldwide, while Monster will become the exclusive energy play of Coca-Cola.

The trading of brands better aligns each business with what it does best. Monster sold $3.1 billion in energy drinks in 2013 in the US, versus $3.4 billion for Red Bull. Monster’s energy drink sales are rapidly rising in the US and will likely be the number one energy brand in the US when the acquisition closes at the end of 2014 or the beginning of 2015.

Adding NOS and Full Throttle sales to Monster’s sales will create an energy business that would have had $3.5 billion in energy drink sales in the US for 2013; larger than Red Bull. Monster is adept at marketing energy drinks in the US. The company will likely be able to position the NOS and Full Throttle brands for faster growth domestically than Coca-Cola has been able to achieve.

Coca-Cola will benefit from Monster’s non-energy drink brands. The Peace Tea brand was the 10th largest ready to drink tea brand in the US by 2013 revenue. Coca-Cola is not a dominant player in the ready to drink tea industry despite owning the Gold Peak , FUZE, and Honest Tea brands. Ready to drink tea has grown over 6% per year over the last 6 years.

The market is expected to continue to grow significantly faster than the overall beverage industry over the next several years as consumers continue to switch from sodas to healthier alternatives. Coca-Cola’s acquisition of Peace Tea will strengthen its competitive position against the larger brands like Arizona, Lipton, and Snapple.

Internationally, Monster trails Red Bull significantly. About two thirds of Red Bull’s sales are international, versus just 23% of sales being from international markets for Monster. Monster should benefit greatly from access to Coca-Cola’s extensive global distribution network. Coca-Cola is the leading seller of carbonated beverages worldwide; the company’s distribution network is second to none.

Coca-Cola is significantly larger than Monster. Monster has a market cap of about $12 billion versus $182 billion for Coca-Cola. Monster is still in its growth phase, as energy drink demand increases year after year. Coca-Cola is a more mature business that is focusing on global expansion funded from its strong cash flows and iconic brands.

Coca-Cola’s stake in Monster will allow the company to participate in Monster’s growth going forward. If Monster can continue to grow its revenue and earnings between 8% and 10% a year, shareholders of Coca-Cola will see additional growth of about 0.1% a year from their share of the company’s growth.

This may seem inconsequential now, but Coca-Cola’s stake in Monster will account for a larger share of its overall growth as Monster grows faster than Coca-Cola in the future. The deal also opens the door for Coca-Cola to acquire a larger stake of Monster later on and aligns both businesses’ futures.

Shareholder Return

Shareholders of Coca-Cola have much to be happy about. The company has a dividend yield near 3%, regularly repurchases shares, and has a long history of growth. Coca-Cola announced it expects to buy back between $2.5 billion and $3 billion worth of shares for the full year of 2014.

This amounts to around 1.5% of the company’s market cap at current prices. Coca Cola has already completed about $1.5 billion worth of net share repurchases this year, and has another $1 billion to $1.5 billion expected for the next two quarters.

Coca-Cola has managed to grow revenue per share and dividends per share by about 9% a year over the last decade, despite headwinds from the slowly declining soda industry. Shareholders of Coca-Cola can expect double digit returns going forward from dividends, share repurchases, and organic growth.

Quantitative Analysis

This section analyzes Coca-Cola and Wal-Mart using the 5 Buy Rules from the 8 Rules of Dividend Investing. Both Wal-Mart and Coca-Cola are compared to each as well as 130 additional stocks with 25 or more years of dividend payments without a reduction. Each rule contains historical evidence on how it can benefit your investing experience.

Rule 1: Dividend History

Coca-Cola has increased its dividend payments for 52 consecutive years
Wal-Mart has increased its dividend payments for 41 consecutive years. Both businesses have raised their dividends for over 4 decades. Coca-Cola has one of the longest active streaks with an amazing 52 consecutive years of dividend increases without a reduction.Why it matters: The Dividend Aristocrats (stocks with 25-plus years of rising dividends) have outperformed the S&P 500 over the last 10 years by 2.29 percentage points per year.

Rule 2: Dividend Yield

Coca-Cola has a dividend yield of 2.9%, the 42ndhighest out of 132 stocks with 25+ years of dividend payments without a reduction.
Wal-Mart has a dividend yield of 2.5%, the 66thhighest out of 132 stocks with 25+ years of dividend payments without a reduction.Both businesses have dividend yields above the market average. Coca-Cola is currently yielding near 3%, which may appeal to income oriented investors.Why it Matters: Stocks with higher dividend yields have historically outperformed stocks with lower dividend yields. The highest-yielding quintile of stocks outperformed the lowest-yielding quintile by 1.76 percentage points per year from 1928 to 2013.

Rule 3: Payout Ratio

Coca-Cola has a payout ratio of 60%, the 96thlowest out of 132 stocks with 25+ years of dividend payments without a reduction. Wal-Mart has a payout ratio of 39%, the 44thlowest out of 132 stocks with 25+ years of dividend payments without a reduction.The lower a company’s payout ratio, the more it can raise its dividend payments above overall company growth. Wal-Mart has a fairly low payout ratio, while Coca-Cola has less room for dividend increases over company growth due to its higher payout ratio.Why it Matters: High-yield, low-payout ratio stocks outperformed high-yield, high-payout ratio stocks by 8.2 percentage points per year from 1990 to 2006.

Rule 4: Long-Term Growth Rate

Coca-Cola has a long-term growth rate of 9%, the 11thhighest out of 132 stocks with 25+ years of dividend payments without a reduction.
Wal-Mart has a long-term growth rate of of 8.2%, the 20thhighest out of 132 stocks with 25+ years of dividend payments without a reduction.Long-term growth rate is calculated as the lesser of 10 year revenue per share growth and 10 year dividend per share growth. Both businesses have had strong growth over the last 10 years.Why it Matters: Growing dividend stocks have outperformed stocks with unchanging dividends by 2.4 percentage points per year from 1972 to 2013.
Source: Rising Dividends Fund, Oppenheimer, page 4

Rule 5: Long-Term Volatility

Coca-Cola has a long-term standard deviation of 18.7%, the 9thlowest out of 132 stocks with 25+ years of dividend payments without a reduction.
Wal-Mart has a long-term standard deviation of 19.1%, the 10thlowest out of 132 stocks with 25+ years of dividend payments without a reduction.Long-term volatility is calculated as the 10 year daily price standard deviation of each stock. Stocks with lower standard deviations tend to rise and fall less than stocks with higher standard deviations.Why it Matters: The S&P Low Volatility index outperformed the S&P 500 by 2 percentage points per year for the 20-year period ending September 30th, 2011.

Final Thoughts

Both Wal-Mart and Coca-Cola are Top 10 stocks based on the 8 Rules of Dividend Investing. Wal-Mart is especially attractive right now as recent poor results have depressed the company’s P/E ratio. If Wal-Mart reports favorable US comparable store sales in the future, the company’s stock will likely rise. Coca-Cola is not undervalued at this time, and is likely a “high quality business trading at a fair price”.

Dividend growth investing is not for everyone. It requires the patience to hold your stock in businesses through the ups and downs of the market. Also, reading and reviewing stock analysis data is important in order to ensure the success of your investment.

The strength of dividend growth investing is that it puts investor focus on growing dividend payments rather than fluctuating stock prices. Only the highest quality businesses can raise dividends year after year. By focusing on high quality dividend growth stocks with a long history of rewarding shareholders, individual investors can build a portfolio that should pay rising dividend income year after year. This can surely help you reach for financial goals faster.

This article was republished with permission from Modest Money.