Coca-Cola (KO 0.58%) surged higher after announcing earnings for the first quarter of 2022. Such results draw attention to the position long held by Warren Buffett's Berkshire Hathaway.
However, its 2022 outlook indicates that it will return to the slower growth of the recent past. Thus, investors might want to consider not following Buffett with this stock.
Image source: Getty Images
Coca-Cola's first quarter
In the first quarter, Coca-Cola reported revenue of about $10.5 billion, 16% higher than the year-ago quarter. The company benefited from a rise in sales and increasing prices for its products. Moreover, concentrate sales surged by 11% on higher volumes and the timing of shipments.
This led to a net income of almost $2.8 billion, a 24% increase over the year-ago period. Slower growth in operating expenses and lower interest expenses more than offset an increase in income taxes, leading to higher profits.
Warren Buffett's Coca-Cola investment
At first glance, these results look like a significant boost to Warren Buffett's portfolio. Buffett owns 400 million shares, around 9.2% of the company. He spent $1.3 billion on shares, most of which he purchased in 1988 and 1989. And with these shares now worth almost $27 billion, he has earned a sizable return.
But it could be the dividend rather than the stock performance that keeps him in Coca-Cola. With annual increases for 60 years, it is a Dividend King. The current dividend of $1.76 per share yields about 2.7%. Admittedly, this is a decent return for new investors, given the average 1.5% cash yield for the S&P 500. Also, Buffett will receive $704 million in Coca-Cola stock dividends this year, taking his annual cash return to 54%!
Given that dividend growth, long-term holders like Buffett should keep their stock. Coca-Cola predicts $10.5 billion in free cash flow this year. The dividend cost the company $1.9 billion in the first quarter -- $7.6 billion if extrapolated to an annual cost. This means that the payout claims 72% of the company's cash flow.
The problem with Coca-Cola stock
That dividend cost should make investors uneasy. The cost of the payout leaves the company with relatively little to invest in its business. Moreover, walking away from a 60-year streak of increases could erode long-term confidence in the stock, so a dividend cut is not likely unless business conditions deteriorate.
And Coca-Cola is not a cheap stock. The 29 price-to-earnings (P/E) ratio makes the stock slightly less expensive than PepsiCo or Monster Beverage, but it is well above the S&P 500's P/E ratio of 21.
Indeed, the recent quarterly increases in revenue and net income may make its P/E ratio more palatable. But for 2022, Coca-Cola expects adjusted earnings growth between 5% and 6%. Such growth might make investors reluctant to pay 29 times earnings, indicating it will struggle to sustain the momentum. That relatively high cost could also explain why Buffett has not bought additional shares since 1994.
Moreover, the company's long-term performance might not appeal to investors. Even when including dividends, Coca-Cola's long-term return has dramatically underperformed the S&P 500 over the last 10 years.
KO total return level. Data by YCharts.
Furthermore, with its flagship beverage available all over the world, it must rely heavily on the more than 200 brands it owns to drive growth. And suspending business in Russia will further reduce net revenue by between 1% and 2%, leading to a $0.04-per-share impact on adjusted EPS. If geopolitical tensions rise, other such suspensions could occur, weighing further on Coca-Cola's earnings.
Coca-Cola looks like a hold
Given Buffett's dividend return from Coca-Cola, he has a tremendous incentive to hold the stock. But instead of buying shares because Warren Buffett owns them, investors should look at possible reasons he has not added any shares in decades. Those reasons likely relate to its sluggish growth at a high cost. Hence, investors who are not earning massive dividend returns should probably not consider this stock.
