Tuesday, October 16, 2012

Coca-Cola: Lacking Fizz

Coca-Cola (KO) is a revered brand, and its stock has long been popular as well.  I'm not a fan of its sugar water, or its stock.

Today the company reported its third-quarter earnings, and the results do not justify its valuation in the stock market.  Its profit rose only 3.9%, and revenues increased less than 1%.  Its dividend yield is 2.7%, somewhat above the average of the S & P 500 Index.  But its dividend payout ratio is 54% of trailing net income and 51% on estimated profits for 2012.  A stock with a payout ratio above 50% should have a much higher dividend yield than only 2.7%.  

Its valuation in the stock market is well above average, at 19 times estimated 2012 profits.  Yet, an analyst at a major investment firm stated that the stock could have multiple expansion, meaning it is worth more than 19 times earnings.  Really?

Furthermore, the company's cash generation is mediocre.  Cash generation, which is the essence of the value of a business, is mediocre relative to Coca-Cola's reported net income.  And after allowing for a generous dividend (larger than what KO currently pays), there would be no cash left over.  "Free cash flow" after capital spending and dividend payments is one of the most important ways to value a stock.

On cash flow, dividend yield (and payout), valuation, and current growth, KO should be left on the shelf.

Steve Lehman

KO:  $37.60

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