Coca-Cola: Implications Of Its Correlation To Interest Rates

| About: The Coca-Cola (KO)


Investors in KO may hold mainly for the yield as opposed to fundamental reasons.

KO's relationship between its yield and interest rates can provide clues about Coke's price based on interest rate expectations.

Investors may see KO shares trade up if interest rates continue their decline.

Coca-Cola (NYSE:KO) is one of the most famous dividend stocks in the world, and for good reason. The company has been increasing its dividend every year for over half a century and is putting in another strong showing this year, with a recent 9% increase in the payout. As such, many investors believe Coke trades less on its fundamentals and more on its yield, thus making it a bond equivalent or fixed income investment rather than a stock. In this article we'll take a look at the interesting relationship between interest rates and Coke's dividend yield to see if we can gain any insight into future price movements.

To do this, I've charted the 10-Year Treasury rate against Coke's dividend yield for the past two years using YCharts.

What's interesting here is that I believe there is a decently strong relationship between the 10-Year and Coke's yield. The 10-Year moves around a lot more than Coke's yield but we can see the relationship all the same. So while the direction is the same in the moves between the two, the magnitudes are different. This is to be expected because if Coke's yield moved as much as the 10-Year, many shareholders would sell simply due to the intolerable volatility. However, I think we can still learn from this relationship.

In a broader sense, if you are long Coke, you must decide on whether to hold your shares. There are many reasons to decide to buy, sell, or hold a security but in Coke's case, I think a lot of investors hold it for the yield and the yearly dividend increases. Thus, the stock's yield is of paramount importance. And given the relationship we can see that exists between broader interest rates and Coke's yield, it makes sense that we as investors understand how that affects our holdings.

I don't have a crystal ball that tells me where interest rates are heading but it seems like the shorter-term move is towards higher rates. The bond market has had ample opportunity to let rates rise and it hasn't and in fact, rates have drifted lower over the past couple months. Regardless, we should understand what movements in either direction mean for Coke's yield.

If interest rates continue to move down I think we've got some pretty strong evidence here that we'd see Coke's yield move down with it. For new investors that would be undesirable because it means not only are you getting a lower yield but you'd also be paying a higher price. That is the part of the relationship we must understand; if rates move down and Coke's price moves up as a result, current holders will be left with capital gains. If rates move up, Coke's price may suffer as its yield becomes less desirable in relation to other income investments. This would be better for new investors or those looking to add to their positions but undesirable for holding Coke shares.

You have to decide what you think interest rates are going to do over the shorter and longer terms and if you still want to hold Coke through those movements. Denying the relationship between interest rates and Coke's yield is done at your own peril given the correlation we see above so the only thing we can do is manage expectations. I happen to think that rates may continue to go lower for the next few months but will eventually turn higher as stimulus is finally removed from the economy. Based on the evidence I've presented here, should that occur, I think we'll see Coke trade into the low to mid-40s depending on the magnitude of the move in interest rates but then potentially turn back down towards the levels it trades at today. But this is something each investor must decide on their own; what do you think?

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.