Coca-Cola: Opportunity Of A Generation

| About: The Coca-Cola (KO)

For decades, investors have known that Coca-Cola (NYSE:KO) was one of the best business models around. And for those same decades, many investors have crunched the numbers and passed on investing because the price was too high. Warren Buffett in the late 1980s was an exception, and did very well despite paying a PE that was near 20 at the time.

What does it look like today, and how does that compare to a long-term history?

Here are a few charts to show you the historical context of where Coke's valuations are.

(click to enlarge) (click to enlarge)(click to enlarge)

On the face of it, Coke's multiple is 21.9 today (based on 2012 earnings), meaning it has an earnings yield of 4.6%. Not normally a value investor's territory if you look at it this way. But as you know, simple PE analysis won't get you very far in investing - we need to dig deeper.

The graphs above show that the valuations (by any metric - dividends, earnings, assets, book value) for Coke have been getting relatively cheaper since 1997. When looked at by Enterprise Value (EV) to Assets, it has never been so cheap, while by the other metrics the only time it was cheaper was in the depths of 2009.

So how can we justify paying almost 22x earnings for a boring company like Coca Cola?

First let's look at the growth history:

What you can see in this graph is that Coca Cola grew relatively poorly in the 5 years right after its peak valuations in 1997! Another strike for the efficient market. This lackluster performance in the early 2000s no doubt explains the drop in valuations, which then continue to drop despite much better growth since 2005.

This is all history, but I realize there's no reason to expect that historically cheap valuations mean they can't continue to get cheaper, not without more analysis.

To get a rough valuation for Coke, let's look at how earnings are distributed vs retained over time (I tweaked the data in only a couple places to cap a couple small negative numbers to 0):

On average, Coke tends to pay out 50% of its earnings in dividends, and ~30% of earnings as stock buybacks (which accrue to your benefit just as steadily).

What about the other 20%? They retain that to re-invest in the business, in theory to give you better results in future years.

By my calculations, the retained earnings over the years (green in the graph above) result in a 30% return on average. I calculated this using 5 years as starting points (1992 through 1996) and 5 years as ending points (2008 through 2012) and got an average return of 30%. I also verified that the growth wasn't driven by the "early years" - I get 32% if I calculate based on the past 5 years only as well.

So if that 20% of retained earnings gives you growth of 30%, that means earnings would be ~$11 billion in 3 years. Here are the detailed projections assuming the stock price doesn't change and the 50%/30%/20% ratios stay steady.

  2012 2013 2014 2015
Earnings 9019 9560 10134 10742
Dividends 4510 4780 5067 5371
Buyback 2706 2868 3040 3223
Diluted Shares (NYSE:M) 4766 4698 4627 4551
EPS $1.89 $2.03 $2.19 $2.36

What this means is that the stock should, even if valuations don't change, be at $52 by end of 2015, which is an 8% or so return per year (not to mention the 3% in dividends along the way!).

There's some chance that the valuations would drop (if interest rates go up dramatically in that timeframe), but I would argue there are equal or more chances of the valuation to rise for a stable global company like Coke.

I generally like to avoid making predictions about where the world will head, and while the table above will look like a projection it is really just an extrapolation of 20 years of history. What this shows is that the return will be pretty good even if nothing changes, which is enough to warrant an investment unless you have some special insight into which direction things will change in.

Disclosure: I am long KO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.