The Big Problem With Coca-Cola Stock

Investors are wildly overpaying for security -- but that trend is changing

   

The Big Problem With Coca-Cola Stock

I’m still surprised by the high price that Coca-Cola (NYSE:KO) is fetching. The stock closed yesterday at $37.74, not far from a 52-week high. I just don’t see how that’s justified.

Let’s look at some numbers. Earlier this week, the company reported Q3 earnings of 51 cents per share, matching Wall Street’s estimate. As we’ve come to expect with companies that do a lot of business outside the U.S., the strong dollar took a bite out of Coke’s profits. Revenue rose only 1% to $12.34 billion, which was $70 million shy of Wall Street’s estimate. The rising greenback knocked 5 percentage points off revenue growth and 7 points off operating income growth. That’s unfortunate, but I doubt that headwind will last.

1018ko The Big Problem With Coca Cola Stock

Still, Coke is going for 17.1 times next year’s earnings estimate. I just don’t see how Coke can justify an above-market premium in an environment like this. Coke’s earnings growth for the next five years is estimated to be 7.43%, which is 2.75% less than what’s expected of the S&P 500.

The current quarterly dividend is 25.5 cents a share, which makes the payout ratio exactly 50%. For the S&P 500, the payout ratio is running close to 30%. Even with that high payout ratio, Coke’s dividend only comes to 2.7%. Many high-quality stocks are yielding much higher than that right now.

By my math, Coke’s fair value is close to $26. Perhaps investors see the Coke brand as similar to a U.S. Treasury. After all, there aren’t many better representatives of American capitalism that Coca-Cola. I think this way of thinking is a huge mistake, but I can see how some investors can justify a 17 P/E for Coke in a world where a five-year Treasury has a P/E of 130.

The major mispricing in the market right now is that investors are vastly overpaying for security, and are underpaying for risk. I believe this trend will slowly unwind — in fact, it’s already started. That explains why U.S. stocks have advanced this year even as earnings estimates have come down. The market is slowly reverting to normal.


Article printed from InvestorPlace Media, http://investorplace.com/2012/10/the-big-problem-with-coca-cola-stock-ko/.

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