Warren Buffett (Trades, Portfolio) is perhaps the most legendary investor of all time. He’s taken a very small textile manufacturing company and – through his investments over the past 50-plus years – turned it into one of the largest companies in the world by market capitalization.
The good news for investors is Buffett’s stock portfolio is made public through filings and, as a result, his positions can be used by dividend investors to find the best stocks. One such stock is The Coca-Cola Co. (KO, Financial).
Business overview and growth prospects
Coca-Cola is the world’s largest beverage company, producing nearly 2 billion servings per day worldwide. Its market capitalization is nearing $200 billion and it sells its products in more than 200 countries around the globe.
Coca-Cola reported strong first-quarter earnings results on April 24. Organic revenue rose 5% as pricing and mix contributed to the increase, as well as a 3% gain in unit case volume. Margins were much stronger as the company pursues smaller, ready-to-consume products in lieu of larger items that are consumed over time. In addition, its operating efficiency efforts are producing strong margin increases, which totaled 600 basis points in the first quarter. The company bought back over $1 billion worth of its own shares during the quarter as well, shrinking the float. This led to adjusted earnings per share rising 13% year over year as Coca-Cola’s positive momentum with volume and margins continues.
Coca-Cola’s refranchising initiative continues to drive revenue lower, but the gains in organic case volume, pricing and mix as well as operating margins have been enough to offset those losses in revenue. The company will see lower revenue through this year, but given the organic gains in revenue, operating efficiency efforts that are well underway as well as the buyback program, the company should continue to grow earnings per share at 6.7% annually in the coming years.
Expected returns and dividend analysis
Coca-Cola is poised for decent long-term annual returns at the current price, primarily the result of a moderate overvaluation in the stock. Shares are trading for a price-earnings multiple of 21.5 on this year’s earnings per share estimate of $2.10, which is well in excess of the company’s long-term average at 18 times earnings. As a result, we expect Coca-Cola to experience a 3.5% headwind to annual returns as the price-earnings multiple drifts back toward its historical norm.
The dividend yield is very strong at 3.5% and, given it is only about three-quarters of total earnings, the payout is safe. We expect Coca-Cola will continue to raise the payout at a mid-single-digit rate in the coming years, congruent with its past practice. We also believe the yield will move higher as the valuation of the stock comes down, combined with a rising payout. Coca-Cola is poised to remain a strong income stock for many years to come.
Combined, the company should produce 6.7% total annual returns in the coming years as its dividend yield and expected headwind from a lower valuation offset each other. That leaves earnings per share growth of 6.7% as providing all prospective shareholder returns.
Coca-Cola is a low-risk stock that is trading over fair value at present, particularly given that income stocks tend to struggle during periods of rising interest rates. Investors that would like to own Coca-Cola should wait for a better entry price as the recent rally has shares looking overvalued at present.
Disclosure: I am not long any of the stocks mentioned in this article.
