I was recently checking out a quote for Coca-Cola (KO) on the E-Trade website, and saw that Coke was trading at $69.92. What I found especially interesting is that E-Trade listed the P/E ratio of Coke at 12.81x earnings, an unusually cheap multiple for a company with such a durable competitive advantage and profit margins as Coke. E-Trade noted that Coke had generated $5.427 of earnings over the past twelve months. I have included the screenshot below to show you the snapshot that I was looking at.
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Here's a chart that documents Coke's earnings per share in every year since 2006. As you can see, from 2006 to 2010, Coke managed to grow earnings per share from $2.37 in 2006 to $3.49 in 2010. That's about what investors expect from an excellent blue chip business: earnings growth in the 8% to low-double-digit range, coupled with the occasional hiccup, such as the -3% earnings per share decline in 2009. But then look at what happened in 2011 -- the earnings skyrocketed 55.30%, judging by the numbers found on E-Trade.
That certainly seems to be eyebrow-raising. 55.30% growth is something that you might see coming from a high-flying technology company or a small-cap with rapid earnings growth, but a stodgy blue chip consumer staple? In terms of normalized earnings, if a mega-cap consumer staple company with a $150 billion capitalization grows earnings by 55.30% in one year, it is probably worth checking out to see if there is a one-time event that is affecting the reported earnings.
So what's going on? Is Coke really trading at 12.81x earnings? No. According to Coke's latest financial statement, the company had a non-tax accounting gain to the tune of slightly over $5 billion as a result of revaluing shares of Coca-Cola Enterprises (CCE). Obviously, this is a one-time source of reported accounting profit that will not be there for Coke in the future, meaning that Coke's seeming 12.81 P/E ratio gives the illusion of cheapness when considered in light of one-time reported sources of profit.
When you subtract this one-time accounting gain, Coke's trailing twelve months of earnings will actually be around $3.87 per share, as opposed to the $5.427 reported on E-Trade that could conceivably mislead you. Going back to the earnings per share chart, we can see that Coke's 2011 earnings per share of $3.87 represents a much more characteristic 10.88% year-over-year increase in earnings, which gives us a more accurate gauge of the true P/E ratio of Coke's stock.
This is a meaningful difference for investors. If you thought that Coke had been generating $5.427 of earnings in the past twelve months, the current price of $69.92 might seem to be a screaming buy with shares only trading at a 12.81x earnings ratio. But if the earnings are only $3.87 per share, then suddenly it appears that Coke is trading at 18.06x earnings, which could very well be a premium that would scare off value investors.
Although it would be nice if the evolution of these stock quoting sites eventually led to asterisks that reported one-time sources of profit, E-Trade is obviously under no obligation to make that type of distinction -- it's up to the investors to do their homework and figure it out. But it does go to show you that you shouldn't reach hard and fast conclusions about any company based solely on these screenshots, and that if a company appears to be especially cheap, it's always worth doing the leg-work to see why it may appear that way.