Coca-Cola: $49 Price Target And 3.2% Yield? Yes, Please

Mar. 6.14 | About: The Coca-Cola (KO)


Coca-Cola shares have hit their highest yield in nearly five years.

Target yield of 2.5% implies 27% upside from current levels.

Annual dividend raises provide downside cushion.

Coca-Cola (NYSE:KO) shareholders have had a rough year, vastly underperforming the S&P 500 during the last twelve months. On top of that, KO shareholders were treated to a rough Q4 earnings report a few weeks ago, sending the stock down again. While Coke is experiencing some issues that shareholders should not overlook, including slowing volume growth, there is still a lot to like at Coke. The company is still the world leader in a gigantic industry, is committed to reducing expenditures to preserve profitability and recently raised its already-robust dividend. In this article, we'll take a look at Coke's yield in the context of recent history as a means to value shares.

To begin, and to see where Coke may go based upon its yield, we must first understand its past. The chart below (sourced from YCharts) depicts Coke's dividend yield for the past five years.

Click to enlarge

What we see here is pretty interesting. We see Coke's yield spike to 4% in the aftermath of the financial crisis as shares were pummeled along with the rest of the market. However, I don't consider those "normal" circumstances as investors were in "sell everything" mode. While it still should be considered among the dataset, I don't think we'll see Coke at 4% again barring some kind of crisis. As an aside, if Coke gets to a 4% yield again, I'll be buying with both fists.

After the crisis-induced high yield, we see Coke shares rallied and the yield dropped to a low of 2.8% in late 2009 just before shares sold off again, subsequently raising the company's yield to 3.4%. This is the yield that marks the high point for Coke shares since the financial crisis and I think it gives us something to shoot against in terms of valuing Coke shares today. After that spike in yield in 2010, Coke shares rallied pretty steadily, with ensuing yields ranging from 2.5% to 2.9%. That is, until recently when shares have sold off and in concert with the dividend raise I mentioned, now yield a robust 3.2%.

So what does this mean for shareholders? I think it means you've got an easy way to understand Coke's relative value given that it is an income stock and has been for a very long time. Coke will never grow at absurd rates again because it is simply too large; you buy Coke for the stability and the income and for that, there are few stocks more suited in this environment.

In terms of valuing shares using the yield, it's pretty simple. We know that the post-crisis high yield was 3.4% and the low, touched two times in the past couple of years, was right at 2.5%. We can use these numbers to trade Coke shares because we know pretty well that at 2.5%, the market is unwilling to continue to bid up Coke shares, so we'll use that as our sell target. Given that Coke currently pays out a $1.22 annual dividend right now, my sell target right now on Coke is $49, or 27%+ upside from today's level of $38.35. Given Coke's propensity to trade within a predictable yield range and the fact that it has sold off so hard in relation to the broader market, Coke looks very attractive at current levels.

The attractive price target on Coke is great but we need to know when to buy in order to ultimately reap those gains. Using the company's yield, history suggests that now is the time to buy as Coke is near its post-crisis high in terms of yield and the last time Coke reached these levels in terms of yield, it was a terrific buy. I don't think this time is any different and as a result, I think you can take a full position in Coke right now. Yes the yield may creep up a bit more before coming back down but it looks like a very one-sided risk/reward scenario right now to me.

The kicker in terms of valuing Coke on its yield is that the company raises its dividend every single year. That is one of the things Coke is very serious about and it works out to the great benefit of shareholders. If you consider that Coke just raised its dividend 8.9% over last year, and that something similar happens every year, even if Coke's yield doesn't move, you're looking at large gains each year simply based upon the stock moving up to accommodate the new dividend. Thus, you don't even have to be a Coke bull in order to reap the benefits of the company's dividend boosting the stock price.

Overall, Coke is a great buy here. I fully acknowledge the company has some issues but what company doesn't? Coke's growth issues will be solved or mitigated and shares will trade back up such that the yield moves towards the 2.5% range again. When that will be is anyone's guess but it will likely take a couple of years given Coke's historical tendencies. Either way, buying today gets you a fantastic entry point on the world leader in beverages and sets you up for large capital gains while collecting a great dividend.

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.