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Over the course of this year, Coca-Cola (NYSE:KO) has risen by nearly 11%. This rise in share price has been accompanied by excellent corporate expansion in the Asia-Pacific and Middle East regions. Despite the fact that Coca-Cola continues its decades-long growth, I believe that shares have temporarily reached a peak. In this article, I will examine the fundamental history of the organization and arrive at a shorting recommendation.

A History of Returns

When an analyst studies a security, he or she should attempt to isolate a few key drivers of share price. By examining factors, which are actually accompanied by movement in shares, we can better position ourselves to profit in the future. In order to fundamentally analyze Coca-Cola, I have relied heavily on a metric known as return on assets. Return on assets is calculated by dividing the net income of a firm by the average total assets across an operating cycle. The usefulness of this metric is that it allows one to analyze the effectiveness of the organization at actually bringing in profits from its existing production capacity. In the specific case of Coca-Cola, the assets used to generate profits are diverse. For example, the largest category, in percentage terms, is "intangible assets," which stands at 17% of total assets. What this means for our analysis is that as we study Coca-Cola's return on assets, we are really studying how much income the firm is able to generate given its entire business operations of research, marketing, advertising and sales. The chart below shows 5 years of history for the Coca-Cola Company.

(click to enlarge)

In the chart above, three distinct economic periods can be seen. In the bullet points below, I have discussed these three time periods and presented a table summarizing the discussion.

  1. The first period of our discussion is the second quarter of 2008 until the second quarter of 2009. During these four quarters, Coca-Cola was in a period of economic decline. The business environment during this time period was that of recession and volatility. As global GDP rates experienced contractions and thousands of banks failed, Coca-Cola came out surprisingly well. This period of time was marked by a slight decrease in return on assets, which means that Coca-Cola delivered slightly fewer profits given its production and sales capabilities, and the stock fell 25%, in a move largely reflective of the overall economy.
  2. Between the third quarter of 2009 and the first quarter of 2011, Coca-Cola experienced a strong rebound in performance. The end of the recession and the stock market averages once again rising was accompanied by growth in Coca-Cola. The strength of KO's rebound was such that return on assets nearly doubled over this short time period. This tangibly means that Coca-Cola was able to deliver twice the amount of profits from the same proportion of assets. Investors flock to securities which are able to generate returns and Coca-Cola is no exception to this rule in that during this time period, shares increased 32%.
  3. The most recent period in the economic history of Coca-Cola is from the second quarter of 2011 until the second quarter of 2013. These eight quarters have been marked by a strong collapse in performance within the organization. Returns have decreased by over half, which tangibly means that Coca-Cola is experiencing weakening performance. What is most troubling about this degradation in growth is the fact that returns have rapidly decreased to a level not seen even during the financial crisis. Despite the fact that the organization is delivering half the return it did in 2011, shares have continued rising by nearly 33%

The table below summarizes the discussion above.

There is a simple fundamental relationship within the market that tends to hold true for most securities: as a firm delivers growing performance its shares tend to rise. Conversely, as a company enters periods of economic malaise, investors flee the stock. This relationship is not terribly complicated and it makes a lot of sense - investors chase return and only allocate capital to organizations which are able to deliver this return.

In the case of Coca-Cola, a very troubling relationship has developed over the past two years. As the company has experienced its largest slump in performance in several years, its stock has continued to rise. Why is this?

It is my belief that Coca-Cola is rising based purely on one thing: a perception of quality and value. During periods of economic fear and uncertainty, individuals run to what they view as "safety." This concept was powerfully demonstrated during the financial crisis as investors haphazardly poured capital into U.S. Treasuries, driving yields to negative levels. I believe that the dramatically uncertain business environment coupled with an active Federal Reserve has led to a host of investors fleeing to securities that they perceive to be safe. Coca-Cola is a "name brand" so to speak and many rational investors believe that name brands hold their value, despite economic volatility. At some point however, investors will eventually wake up to the fact that they have been pouring capital into a security which is delivering diminishing returns. Even though Coca-Cola has a "moat," or strong competitive edge, the economic laws of business cannot be violated in the long run. Coca-Cola has experienced the largest degradation in performance in several years and I believe that shares will correct in the near future as investors "wake up" to the fact that their temporary perception of value is contrary to the actual definition of investing quality.

It is my belief that the shrewd investor should give serious thought to selling shares, buying puts, or shorting the security to profit from the market's oversight.

Source: Coca-Cola: Short The Market's Oversight