Coca-Cola: Lagging Fundamentals May Impede Further Dividend Growth

| About: The Coca-Cola (KO)

Let’s check out a stock that is held by the Oracle of Omaha, Warren Buffett - The Coca-Cola Company (NYSE:KO). Of course, this stock is an S&P 500 Dividend Aristocrat.

Company Profile:

I think everybody knows this one, but what the heck.

From Yahoo Finance:

The Coca-Cola Company engages in the manufacture, distribution, and marketing of nonalcoholic beverage concentrates and syrups worldwide. The company offers nonalcoholic beverages, principally carbonated soft drinks, as well as noncarbonated beverages. Its beverage products comprise bottled and canned soft drinks and beverages products. The company markets its nonalcoholic beverages under various brand names, including Coca-Cola, Diet Coke, Fanta, and Sprite.

This is a large cap stock with a market capitalization of $121.66B.

Company Fundamentals:

Let’s have a look at the company fundamentals to make sure that any dividend that they are paying is sustainable and growing.

First stop is to check the Return on Equity. This is our report card on management. And I must say, Coca-Cola Co. passes with flying colors. The ROE has been consistent over the last 10 years at a whopping 30%! The 10 year average is 36.68% and the 5 year average is 31.98%. The trend shows the ROE slipping just a bit, but these are amazing numbers.

Looking at the equity growth rate, I see some numbers that concern me. Equity growth rate has not been consistent and has drastically dropped off the last two years. Equity growth rate for the last two years are 4.38% and 5.72%. I would definitely prefer to see the equity growing at a higher rate.

Earnings per share growth rate is also concerning. Not much consistency over the last 10 years and the last two have been particularly meager with rates of 3.38% and 1.40%. With such low growth rates, Coca-Cola should not be able to grow their dividend quickly.

Sales growth rate has been fairly consistent in the 5% range. Remember that this is an absolutely huge company and growing billion dollars of sales can be a difficult task.

Dividend Fundamentals:

Current dividend yield is sitting at 2.58%. That is slightly higher than the yield on the Dow Jones 30 and definitely higher than the yield on the S&P 500.

Looking at the dividend growth rate for the last 10 years, we see a healthy dividend growth rate of around 11%. Wow. Coca-Cola Co. has been able to grow their dividends at over 10% a year but their earnings per share growth rate and sales growth rate have been relatively low at under 5%.

And to confirm that lack of growth, I also see that the cash flow growth has been anemic over the last couple of years at under 5%. I find this troublesome that the company can grow their dividend at a nice 10% rate, but not have the fundamentals growing at the same pace. Let’s press on.

Historical Dividend Yield:

Looking at the last 10 years of dividends, I have calculated an average high dividend yield of 1.97%. However, that seems a tad low considering that each of the last 4 years is significantly higher than that amount. If I average out just the last 4 years of high dividend yields, I come up with 2.73%. Still lower than the average high yield of the last 2 years.

And now the dividend payout ratio. Ah ha! This explains how they were able to increase dividends at 10% even when the fundamentals have not been growing as quickly. Look at the increase in the payout ratio. It has grown from a low of 34.15% in 1997 to a high of 57.14% in 2006. It has just been a steady climb up for the last 10 years.

Using the 2.73% as an average high dividend yield, I calculate a price of $49.82 to be able to collect this average high dividend yield. At close on Friday June 1, the current price was $52.80. That means a premium of 5.99% over the price I am willing to pay.

Check my calculations here.

Conclusion:

Well, my analysis shows that Coca-Cola’s fundamentals have not been keeping up with their very healthy dividend growth. This has caused Coca-Cola to have to payout more and more of its earnings to shareholders. This concerns me because eventually they will not be able to raise their dividend at these high rates since their dividend payout ratio will be too high.

I am sure that Warren Buffett is earning a healthy dividend on his KO stocks, but personally, I would pass on this one today. There are stocks out there that continue to grow their fundamentals which will in turn allow them to grow their dividends.

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