Start Your Passive Income on a Market Down Day

Some people don’t know where to start their passive income. One can’t go wrong by buying shares in dividend growth companies which are multi-national brands on a market down day. We exactly experienced this last Thursday. On one hand, I don’t like seeing the red ticker prices. On the other hand, this drop in stock prices reminds us to seize the opportunity to grab quality companies at lower prices and higher yields. However, we need to first be prepared! If you have been storing up some dry powder, it is time to get that watchlist out and decide which sector you need more exposure in, and which companies to buy in those sectors. That said, I don’t think the market has finished its downward movement yet. Because I don’t have enough cash to buy shares in all of the companies on my watchlist, the first step is to review the list, so that I’m ready to buy some good valued shares when they reach my buy zones. Allow me to start off with 3 companies in the business of selling beverages, snacks, and food: Coca-cola (KO), Pepsi (PEP), and McDonald’s (MCD).

The above companies are commonly found in dividend growth portfolios. Morningstar currently gives them 4-stars, meaning they’re undervalued, so it is time to take another look to see if they are a fit in your portfolio or a fit to add shares in.

Coca-cola Analysis

Price: $39.76. Yield: 2.82%
Sector: Consumer Staples
S&P rating: AA-

Coca-cola sells non-alcoholic beverages such as soft drinks, energy drinks, teas, coffees, juices, and water. It has a strong global brand and distribution system, selling its 3,500+ products in over 200 countries. To name a few, some of KO’s well-known brands include Coca-cola, Sprite, Fanta, Diet Coke, Coca-cola Zero, Dasani, Minute Maid, and Powerade. Coca-cola has a long history, bringing happiness to almost every stretch of the globe since 1886, and it has been paying growing dividends for more than half a century! Coca-cola’s dividends serve well as part of any investor’s passive income.

Coca-cola’s Earnings and Dividend Growth

For the past 10 years, KO grew its earnings per share [EPS] 9% annually, while its dividends grew 9.8% annually. Its lowest dividend growth was 6.8% in 2011, but it still exceeded inflation rate. With its earnings growth expected to be around 9%, we can expect for its dividend to grow in the 6% to 9% range in the near future.

Coca-cola’s Cash and Debt

Coca-cola currently has a debt to capital ratio of 30%, which is much lighter than Pepsi’s 51%. This is good especially as interest rate steadily rises. KO is sitting on a huge cash pile, a free cash flow [FCF] of over $6200M. To determine the safety of its dividend, I’m going to use this idea. So, with 4.45B outstanding shares, a dividend of $0.28 per share, and FCF of $6280M, we get the dividend/FCF ratio to be ~20%, so the dividend is easily sustainable.

Coca cola's 10 year passive income and fundamentals graph

The FAST graph shows that KO is at fair value, but is at the higher end of its [blue] normalized PE range. It is not a bad idea to initiate a position now if you’re a long-term investor, and planning to hold it for many years. However, an investor looking for a better buy can wait until $37.5 or lower before averaging in. ($37.5 is the mid-point of its historical PE line and the [orange] earnings line.)
Coca Cola's Finviz technical graph
Technically, if KO breaks the blue support line, it might work towards its SMA 200 in the low $38 range.

Pepsi Analysis

Price: $80.13. Yield: 2.83% )
Sector: Consumer Staples
S&P rating: A

Pepsi is a leading food and beverage company, whose brands include household names like Pepsi, FritoLay, Tropicana, and Quaker. Coincidentally, like Coca-cola, Pepsi also sells its products in over 200 countries. In fact, amongst Pepsi’s diverse range of products, it has 22 brands which each generates north of $1B in sales every year. Pepsi has been growing its dividends for over 40 years. Pepsi’s dividends serve well as part of any income-oriented investor’s passive income.

Pepsi’s Earnings and Dividend Growth

For the past 10 years, PEP grew its earnings per share 7.6% annually, while its dividends grew 14.5% annually, with the recent dividend growth being its lowest in the decade at 5.6%. It looks like Pepsi’s recent dividend growth is not supported fully by earnings growth. As dividend growth was much greater than earnings growth in the past 10 years, it makes sense why Pepsi’s last dividend growth, especially, has slowed. With its earnings growth expected to be around 8%, we can expect for its dividend to grow in the 5% to 8% range in the near term.

Pepsi’s Cash and Debt

Pepsi currently has a debt to capital ratio of 51%, which is an acceptable amount of debt. It is sitting on a free cash flow of over $3700M. To determine the safety of its dividend, I’m going to calculate its dividend/FCF ratio. So, with 1.55B outstanding shares, a dividend of $0.57 per share, and FCF of $3727M, we get the dividend/FCF ratio to be ~24%, so Pepsi’s dividend is easily sustainable.
Pepsi's 10 year passive income and fundamentals graph
The FAST graph shows that Pepsi is not a bargain right now. An investor looking for a value price might consider starting a position below $73.86 (the mid-point between the normal PE and the earnings line).
Pepsi's Finviz technical graph
Technically, PEP is experiencing a short-term bounce. If it does break through that trend in a downward motion, its next major support is in the high $73 level.

McDonald’s Analysis

Price: $97.23. Yield: 3.17%.
Sector: Consumer Discretionary
S&P rating: A

McDonald’s is a global food service retailer with footprint in 118 countries. There are over 34000 McDonald’s restaurants worldwide serving ~69 million people every day. Of those thousands of restaurants, 80% are franchised. McDonald’s has been paying a growing dividend for over 30 years. McDonald’s dividend history indicates it provides the highest passive income growth out of the 3 companies analyzed here.

McDonald’s Earnings and Dividend Growth

For the past 10 years, MCD grew its earnings per share 15.8% annually, while its dividends grew 24.5% annually. Its lowest dividend growth was 8% in 2008. That was probably just an anomaly as it was changing from a single annual dividend to paying a quarterly dividend starting in 2008. With its earnings growth expected to be around 9%, we can expect for its dividend to grow at least 9%.

McDonald’s Cash and Debt

McDonald’s currently has a debt to capital ratio of 46%, which is a healthy amount of debt. It is sitting on a free cash flow of over $1200M. To determine the safety of its dividend, I’m going to calculate its dividend/FCF ratio. So, with 1B outstanding shares, a dividend of $0.77 per share, and FCF of $1243M, we get the dividend/FCF ratio to be ~61.9%, which makes McDonald’s dividend a sustainable one.
McDonald's passive income and fundamentals graph
The FAST graph shows that McDonald’s share prices are historically priced at a premium. Right now, it is not a bargain. An investor looking for a valued price might consider starting a position below $91.75 (the mid-point between the normal PE and the earnings line).
McDonald's Finviz technical graph
Technically, MCD is currently stuck in a downtrend range. If it breaks the support indicated by the blue line, its next strong support is in the $93 area.

In Summary

Ticker *Price ($) *Yield (%) 10 Year (Annualized) Buy Zones ($)
EPS Growth Dividend Growth
KO 39.76 2.82 9 9.8 37.5 – 38 or lower
PEP 80.13 2.83 7.6 14.5 74 or lower
MCD 97.23 3.17 15.8 24.5 91.75 – 93 or lower
* June 21, 2013 closing

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Disclosure: I am long KO.

Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.

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