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The Coca-Cola Company Message Board

  • dmtacy dmtacy Jan 12, 1998 8:24 PM Flag

    I want an explanation

    Can someone who likes this stock explain to me why people are paying 40x earnings for it. Anticipated earnings growth this year is like 4%. Coke is noncyclicial, but is susceptible to worldwide depression. Longterm growth from here on won't be fantastic. Why on earth would anyone pay $60+ for a stock that earns $1.60 and a dividend ratio of less than 1.
    For what its worth, I think that this stock is an excellent example of why this market is overvalued. There seem to be certain stocks that people get irrational about and just buy. So does anyone have any ideas? Some kind of explanation from a KO enthusiast would be appreciated.

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    • See if I can offer a short answer to this one.

      KO's five year average return on equity (ROE) is roughly 50%, (now it's 60%). Cash dividend payout is 32%. That means 68% of the net earnings are retained by the company to add on to the equity base. Theoretically, equity should grow about 34% annually (50% * 0.68 = 34%). In reality, it may grow a little bit less than that, depending on how efficient managers allocate those retained earnings. Coke's people have a good reputation on this one.

      Five years from now, equity base should grow to between 3 to 4 times its current size. We know KO's historical P/E ratio is
      between 25-40. Now it's close to the high end. Let's assume KO trades at the recent historical average P/E of 30 in five years, its
      market cap certainly cannot triple because of P/E retraction. But it should be able to double its current size. That's about 15%
      capital appreciation annually. Not spectacular, but acceptable under the current market conditions. Of course, one improves the
      return if the purchase is made at a lower P/E ratio. I personally prefer to purchase KO at a P/E of 25 and ride it all the way up
      to 40. But it's not realistic at this moment.

      Motley Fool's argument for PEP over KO is not convincing, at least to me. PEP's ROE is only half of KO and its dividend payout is almost the same as KO. The P/E ratio is not exactly low, either. It's probably not as reliable as KO, as history shows.

    • dmtacy wrote:

      <<Can someone who likes this stock explain to me why people are
      paying 40x earnings for it. Anticipated earnings growth this year
      is like 4%. Coke is noncyclicial, but is susceptible to worldwide
      depression. Longterm growth from here on won't be fantastic. Why
      on earth would anyone pay $60+ for a stock that earns $1.60 and a
      dividend ratio of less than 1. For what its worth, I think that
      this stock is an excellent example of why this market is
      overvalued. There seem to be certain stocks that people get
      irrational about and just buy. So does anyone have any ideas?
      Some kind of explanation from a KO enthusiast would be
      appreciated.>>

      I'm not going to attempt to defend KO's stock price -- it's
      occurred to me as well that it's a bit rich. However, I am a KO
      shareholder and I am sold on the overall excellence of KO as a
      company. Briefly, here's why:

      1) Excellent management. Since the mid-1980s, KO's management has
      been able to achieve spectacular returns on equity and earnings
      growth rates by shedding stupid diversification moves made in the
      70s and becoming the dominant force in international soft drink
      sales. Douglas Ivester may be a new CEO, but he is a long-time
      member of KO's management team; therefore, I expect this
      excellent management to continue.

      2) Most recognized brand in the world. Even an idiot could make
      tons of money with the Coca-Cola brand name, and KO is not run
      by idiots.

      3) Outstanding prospects for overseas growth. International sales
      account for 80% of KO's profits, and the internaitonal market is
      not even close to saturation. The average person from India or
      China consumes between 2 and 3 KO beverages per year, less than
      one percent of the 360 or so the average person from the United
      States consumes. Coca-Cola has demonstrated an ability to achieve
      dominant market share in foreign markets, and I believe that they
      can do it in India, China, and other markets where they do not
      now have a huge presence. KO could realistically see 20% growth
      in some huge foreign markets like India and China for more than
      a decade, and these markets are home to more than 2 billion
      people. Maybe KO will only see earnings growth of 4% next year
      (although I really question the ability of analysts to forcast
      earnings with any acceptable degree of accuracy), but its
      prospects for long-term double digit earnings growth are still
      excellent.

      You say that KO is susceptible to a worldwide depression. This is
      true, but just about every company would see hard times in the
      event of a worldwide depression -- if you believe that we are
      entering a worldwide depression, then I question whether you
      should be putting your money in any equities at all.

    • If you can give me a good reason why someone would spend $0.60 for a can of sweetened water, and do this every day, year-in and year-out (U.S. consumption, 8 ounce servings), than that is the reason to buy Coke. Water is much cheaper than Coke, perhaps one should buy American Water Works (AWK).

      • 2 Replies to atmacdonald
      • I believe you have a point and that explains some of it. But the more fundamental point is why are people paying so much for
        Coke's future earnings. Coke has a quasi-monopoly on a very stable market, BUT why pay 40x earnings for a company who expects 4%
        EPS growth this next year and into the future? Coke definately makes easy money turning water into gold (Coke) but that still
        doens't justify current levels. The way I figure it Coke should be between a P/E of 20 and 30, probably closer to 20 unless earnings
        growth picks up. Well, this is of course just a personal opinion, I'm just curious why people pay so much for it. Thanks.

      • You are correct that water is cheaper than a can of Coke in the US, but it is a different story overseas. If you have ever been to Europe, for example, water is actually more expensive than Coke and believe it or not, beer. Since a large percentage of revenues come from overseas (roughly 50%) I do not see this being an issue. Also, have you ever requested a water with your McDonald's Big Mac value meal?

    • KO, for me, has been a fantastic investment. I've enjoyed two
      stock splits in a relatively short period of time. My only regret
      is not purchasing COCA-COLA much earlier in my life as I'm
      now a senior. Yes; Coke is the most recognized symbol on
      the planet earth. Yes; I drink at least two cans of coke a
      day as well as other coca-cola products. Yes; I promote
      my company every chance I get. AND Yes; Buy now and
      in the mid term, three to five years, the rewards will be
      substantial. P.S.---I'm personally not concerned with the
      higher P/E ratio.

      • 1 Reply to RichardTheodore
      • I realize Coke has been an excellent investment over the last couple years. But that in no way means that it will continue to be a good investment. It is known for a fact that on average, stocks w/ a higher P/E have lower returns and the reasons why are obvious. You are paying a higher price when stocks have higher P/E's.
        Now obviously you are paying for brand name/recognition worldwide, but does it justify the current price? I don't think so. Coke has been a great bet over the last 10 years but my point is that it doesn't look so good now until earnings catch up.

 
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