By now everyone knows about Coca-Cola's (KO) proposed stock split. Or so we thought. We were surprised to see no articles have been published so far on Seeking Alpha about the stock split. A recent article on MarketWatch talked about how stocks that split shot up in price for no apparent reason. When a stock splits, the financials do not change and neither does the business outlook. But maybe it's human psychology that makes people think a $50 stock is "cheaper" than a $100 stock. The article goes on to list a few instances of the stock gaining value once the split is executed. However, one can also find an equal number of cases where the stock did not move much after a split.
When one looks at why Coke has increased in price after splits, you can see a parallel with increasing dividends and increasing earnings. But the article also goes onto say how Coke has other factors making it a good investment, including dividends. So, fair enough. This article takes the dividend factor one step further and evaluates how Coke's dividend growth would affect your investment, if you decide to buy it at the current price level.
Coke has increased its dividends regularly and is a dividend aristocrat. Its current payout ratio is a comfortable 50%. With these basics out of the way, let us see what a conservative investor can hope to achieve over a 10 year period setting aside his/her money with Coke.
- Assume you purchase 1,000 shares at the recent price level of $75 for a total initial investment of $75,000.
- The current yield works out to 2.7% as shown in the table below.
- A dividend growth rate of 7% is assumed, even though Coke's average dividend increase over the last five years is 8.5%.
- Notice how the dividend payments and the yield on original cost double in 10 years, leading to $4,000 in annual dividends.
- We have left out the DRIP part from this piece as some investors choose to reinvest the dividends and some do not. Some DRIP during bad times to accumulate more shares and opt out of DRIP when the price per share seems to be at a fair value.
- Capital gains will almost certainly contribute to the overall returns as well. And now with the proposed split, there is a high probability of stock price appreciation. Not to forget the international growth.
- However, in case the price dips, turning on the DRIP will be helpful in maximizing the returns when things turn around.
- Inflation has been ignored in this calculation as stocks are the best hedges against inflation when compared to other assets.
- 10 years is a reasonable time period for this exercise as the market typically moves through many cyclical highs and lows in a decade.
Conclusion: While there is no denying that stock splits pay a role in price appreciation on a few stocks, dividends and dividend growth are far better metrics when it comes to evaluating stocks. When your yield doubles in a decade (with no DRIP) and even a conservative dividend growth rate, why bother about the other not so reliable factors like a stock split?
Disclosure: I am long KO.