Applying The DGI Spreadsheet On Coca-Cola

| About: The Coca-Cola (KO)

Summary

A DGI spreadsheet is used to calculate the future returns of KO based on its current dividend and a conservative dividend growth rate.

The returns after a 20-year horizon are calculated with and without including the expected capital appreciation of the stock. The results in both cases that should be satisfactory for most investors.

Investors can use the DGI spreadsheet to determine whether a stock is likely to achieve their retirement goals, or if they need to invest additional amounts every year to meet these goals.

Dividend growth investing [DGI] is an extremely popular strategy on Seeking Alpha thanks to its great characteristics. For instance, during a stressful, volatile period for the markets, like the current one, DGI investors do no have to pay attention to the temporary gyrations of the market. Instead they focus on the annual growth of their income stream. A few days ago, I published an article that provided a spreadsheet that calculated long-term future returns of DGI portfolios, based on their initial average dividend yield and their dividend growth rate. That spreadsheet can help DGI investors build reasonable expectations on the long-term performance of their portfolio and thus conclude whether they should increase their contributions in the portfolio in order to meet their retirement goals. In this article, I will apply the results of that spreadsheet on Coca-Cola (NYSE:KO) in order to calculate the expected returns of the stock after a period of 20 years.

Coca-Cola is a classic holding of many DGI portfolios thanks to its wide moat and its exceptional record of dividend growth. To be sure, the company has raised its dividend for 53 consecutive years. Moreover, it is a core holding of Berkshire Hathaway (NYSE:BRK.B), which is well known for pursuing high-value stocks with a great competitive advantage. Nevertheless, the dividend growth rate of the stalwart has been in a downward trend in the last decade, as shown in the chart below.

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The spreadsheet provided in the above mentioned article calculates the future value of the portfolio based on the initial capital that is invested, the initial average dividend yield of the portfolio and the average annual dividend growth rate. The spreadsheet has been built for a period of 30 years, but it can be easily adjusted for a different period by adding or deleting rows and columns. In addition, it is assumed that the dividends collected every year are reinvested, with an initial yield equal to the initial dividend yield of the portfolio. Then the reinvested dividends enjoy an increasing yield, which grows at the same rate as the dividend yield of the rest of the portfolio. For simplicity, the spreadsheet does not involve additional amounts of capital every year.

In this article, as we want to forecast the future returns of Coca-Cola, we will assume (in the spreadsheet) that the portfolio includes only this stock, which currently offers a 3.1% dividend yield. Of course DGI portfolios are well diversified, but it is useful to know the contribution of each stock in the total results of a portfolio. To be conservative, we will use a dividend growth rate of 6% in the spreadsheet. While it is evident from the above chart that the dividend growth rate of the company has fluctuated above 6%, in the 7%-14% range in the last 12 years, it is prudent to use a conservative growth rate, as the size of the company may keep forcing it to reduce its dividend growth rate in the long term. In any case, it is better to have a positive than a negative surprise after holding the shares for years. Moreover, we have used $100,000 as initial capital and have performed the calculations for a 20-year horizon. The results are shown in the chart below:

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If one ignores the capital appreciation, the initial capital of $100,000 will grow to $252,037 after 20 years thanks to the dividends earned from the initial capital and the reinvestment of dividends. In the final amount of $252,037, the contribution of the initial capital is about 40%, the contribution of the dividends earned from the initial capital is about 45% ($114,000) while the contribution of the reinvestment of the dividends (about $38,000) is about 15%. These figures can help investors realize the relative importance of each component in the long-term results of their DGI portfolio. Of course the relative contribution of each component will change depending on the time horizon, the initial dividend yield and the dividend growth rate. That's why the spreadsheet is useful, as it can predict the effect of changes in these parameters on the performance of a portfolio.

If one wants to include the capital appreciation in the future value of the portfolio, it is reasonable to assume that the stock will grow at the same average rate as the dividend growth rate. Of course there are no guarantees, and there may be great fluctuations during a 20-year horizon, but there is no better estimate to be used. This assumption is based on the premise that most of the time Coca-Cola will not deviate much from its current 3.1% dividend yield. If the stock does not catch up with its growing dividend, the dividend yield will rise to abnormal levels. Conversely, if the stock rises much more than its dividend, its dividend yield will fall to unattractive levels. Therefore, as the above chart shows, if one includes the capital appreciation, the initial $100,000 will grow to $435,189 after 20 years. In other words, the appreciation of the stock will provide additional returns of about $183,000. Both results (with and without capital appreciation) should be comforting to the shareholders of Coca-Cola, particularly given that a fairly conservative dividend growth rate has been used, at least compared to the historical rates.

Of course the above results depend on the above-mentioned assumptions that were used in the spreadsheet. If the management of Coca-Cola fails to return to earnings growth for many years, it may be forced to grow the dividend at a slower pace. However, as the company has failed to grow its earnings in the last 3 years, the management is implementing a thorough cost-cutting initiative. Hopefully, when this project starts to bear fruit, the results of the company will return to growth trajectory. The future results may also be helped by sound acquisitions and/or promising partnerships with other beverage companies, like the ones established with Keurig Green Mountain (NASDAQ:GMCR) and Monster Beverage (NASDAQ:MNST).

All in all, the calculated returns of Coca-Cola within a 20-year horizon based on the current dividend yield and a dividend growth rate of 6% should be satisfactory for most investors. SA readers can modify the growth rate in the spreadsheet to determine the sensitivity of the results presented above. Moreover, they can conclude whether the above returns meet their retirement goals, or if they need to invest additional amounts on an annual basis to meet these goals.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.