Usually in these "Better Buy" articles, we pit against each other companies that operate in the same industry. But every now and again, we get odd pairings. This is one of them: a vendor of sugary water in Coca-Cola (NYSE: KO) versus a computing purveyor in IBM (NYSE: IBM) .
I personally love these disparate duos; in the real world, these are the types of decisions that individual investors -- particularly dividend investors -- have to make every day.
Image source: Getty Images.
So which company is a better buy at today's prices? Obviously, I can't give you an answer with 100% certainty (if I could, I'd be retired already...), but I can suggest three different lenses through which you can evaluate the question.
Many investors -- especially those focused on dividends -- love to see the bulk of cash that a company produces flow back to shareholders in the form of dividends. This makes sense; that's why they invested in the companies to begin with.
But there's something to be said for keeping a pile of cash on hand. That's because every company, at one point or another, will face tough times. Whether the setbacks are due to macro conditions or company-specific in nature, companies that face challenges with lots of cash and little debt will actually emerge stronger. That's because they can outspend rivals, keep paying their dividends, buy back shares, or even make strategic acquisitions.
Debt-laden companies find themselves in the opposite situation -- forced to narrow their focus to avoid being bankrupted entirely.
Here's how Coke and IBM stack up in terms of financial fortitude.
Free Cash Flow
Data source: Yahoo! Finance. Cash includes cash, short- and long-term investments
Here, we have a difficult situation in crowning a winner. On the one hand, Coke's cash position is far superior to IBM's, especially relative to the debt that each company has. On the other hand, IBM -- while having a valuation about 10% smaller than Coke's -- is able to produce enviable free cash flow (FCF). In fact, its FCF is nearly three times that of Coke.
When I combine these two facts, I think that what we have here is a draw.
Winner = Tie
Sustainable competitive advantages
There's no variable that's been more indicative of the long-term results of my investments than the sustainable competitive advantages of the underlying companies. Often referred to as a "moat," a company's sustainable competitive advantage is what separate it from the horde of competitors.
In essence, a company's moat provides that special something that makes it unique. Over the months, years, and decades, it is the moat that provides the type of returns that can create dynastic wealth.
In Coke's case, the moat is provided by two things: scale and brand. The company's scale allows overhead costs associated with producing and distributing products to eat up less and less of overall sales. But let's be honest, with a host of other slightly smaller competitors, scale isn't that big of a moat widener.
The company's real moat comes from the power of its brands. In fact, brand-analysis company Interbrand rates Coke as the third most valuable brand in the world, worth $73 billion, and coming in behind only Apple and Alphabet 's Google. Coca-Cola also owns more than just its namesake brand. It owns Sprite, Fanta, Dasani, and Powerade, to name a few.
IBM, on the other hand, has two different lines of business. One -- based on providing the hardware that big businesses need -- is slowly dying. But a new one -- dubbed "Strategic Imperatives" -- is focused on harnessing the power of cloud computing to help businesses use artificial intelligence and data analytics. The newer line now accounts for 40% of the company's sales. Once companies get hooked on IBM's services, the switching costs can be high.
Comparing the two companies is difficult. One the one hand, Coke's brand has stood the test of time; yet the company is under fierce attack as consumers want drinks with less and less sugar -- the very bread and butter of Coke's brand.
With IBM, cloud computing is providing a new moat with high switching costs, but we are still in the very early innings of this transition, and the company is facing players that have a huge head start in the space: Alphabet, Microsoft , and Amazon.com .
In the end, I'd rate both Coca-Cola and IBM as having medium-strength moats.
Winner = Tie
Finally, I'll look at valuation. It is this metric that will finally produce a clear winner.
Data sources: Yahoo! Finance, E*Trade, Morningstar. P/E represents figures from non-GAAP earnings. Note that Coke did not pay a dividend during the most recently reported quarter due to a slightly later ex-dividend date. The payout ratio assumes a consistent dividend payment. PEG = price/earnings to growth.
On every metric, IBM comes out as the cheaper option. Perhaps most important for dividend investors, IBM has a ton of wiggle room when it comes to the payout. Only one-third of FCF was used to pay its hefty dividend. The same could not be said for Coke, which has far less potential to grow its dividend over time.
Winner = IBM
And the winner is...IBM
So there you have it: IBM is the better bet at today's prices. Both companies have medium-strength balance sheets and moats, but IBM is far and away the better bet when it comes to valuation. If you are a dividend investor, giving a little more due diligence to IBM could be to your long-term benefit.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's Board of Directors. LinkedIn is owned by Microsoft.
Brian Stoffel and The Motley Fool own shares of -- and The Motley Fool recommends -- Alphabet (A and C shares), Amazon.com, and Apple. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool recommends Coca-Cola. The Motley Fool has a disclosure policy .
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