PepsiCo: Dividend Dynamo, or the Next Blowup?

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Dividend investing is a tried-and-true strategy for generating strong, steady returns in economies both good and bad. But as corporate America's slew of dividend cuts and suspensions over the past few years has demonstrated, it's not enough simply to buy a high yield. You also need to make sure those payouts are sustainable.

Let's examine how PepsiCo (NAS: PEP) stacks up in four critical areas to determine whether it's a dividend dynamo or a disaster in the making.

1. Yield
First and foremost, dividend investors like a large forward yield. But if a yield gets too high, it may reflect investors' doubts about the payout's sustainability. If investors had confidence in the stock, they'd be buying it, driving up the share price and shrinking the yield.

PepsiCo yields 3.4%, considerably higher than the S&P 500's 2%.

2. Payout ratio
The payout ratio might be the most important metric for judging dividend sustainability. It compares the amount of money a company paid out in dividends last year to the earnings it generated. A ratio that's too high -- say, greater than 80% of earnings -- indicates that the company may be stretching to make payouts it can't afford, even when its dividend yield doesn't seem particularly high.

PepsiCo has a moderate payout ratio of 49%.

3. Balance sheet
The best dividend payers have the financial fortitude to fund growth and respond to whatever the economy and competitors throw at them. The interest coverage ratio indicates whether a company is having trouble meeting its interest payments -- any ratio less than 5 is a warning sign. Meanwhile, the debt-to-equity ratio is a good measure of a company's total debt burden.

Let's examine how PepsiCo stacks up next to its peers:

Company

Debt-to-Equity Ratio

Interest Coverage

PepsiCo128%12 times
Coca-Cola (NYS: KO) 89%26 times
Dr Pepper Snapple120%9 times
Kraft Foods81%4 times

Source: S&P Capital IQ.

These beverage and food makers -- particularly high-moat giants Coke and PepsiCo, whose costs of debt are quite low -- are able to carry moderately high debt-to-equity ratios because their businesses are seen to be incredibly stable.

4. Growth
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.

Company

5-Year Earnings-Per-Share growth

5-Year Dividend Growth

PepsiCo4%12%
Coca-Cola11%9%
Dr Pepper Snapple6%0%
Kraft Foods(1%)4%

Source: S&P Capital IQ.

Even though both Pepsi and Coke have comparable proportions of their sales coming from fast-growing markets (34% of Coke's revenue comes from outside North America and Europe, 30% for PepsiCo), Coke's growth edge stems in part from its hugely successful international presence and, recently, price increses in North America.

The Foolish bottom line
So, is PepsiCo a dividend dynamo? With a moderately high yield, modest payout ratio, limited debt burden, and a small bit of growth, it could very well be. If you're looking for some other great dividend stocks, I suggest you check out "Secure Your Future With 11 Rock-Solid Dividend Stocks," a special report from The Motley Fool about some serious dividend dynamos. I invite you to grab a free copy to discover everything you need to know about these 11 generous dividend payers.

At the time this article was published Ilan Moscovitzdoesn't own shares of any company mentioned.The Motley Fool owns shares of PepsiCo and Coca-Cola.Motley Fool newsletter serviceshave recommended buying shares of Coca-Cola and PepsiCo and creating a diagonal call position in PepsiCo. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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