Coca-Cola (KO) looks like one of the more appealing Warren Buffett stocks at first glance. The 400 million shares owned by his company Berkshire Hathaway make up more than 9% of shares outstanding. Also, from an original $1.3 billion investment, it is on track to generate $704 million for Berkshire in dividend income alone, a 54% annual return.
But despite this success, investors should not consider following Buffett into Coca-Cola stock. Three reasons illustrate why this might turn into a losing proposition for investors.
1. Coca-Cola's stock and dividend growth
Admittedly, those looking at the company's stock performance may want to ignore the advice to stay away as Coca-Cola reaches record highs. Over the last 12 months, it logged a 14.8% total return level (including dividends) and outshined the S&P 500's total return of -3% over that time frame. Moreover, Coca-Cola is a Dividend King, a title earned by 60 straight years of payout hikes.
However, Coca-Cola has underperformed the S&P 500 on a longer-term basis. Over the last 10 years, Coca-Cola stock logged a total return of about 125% compared with almost 270% for the S&P 500.
Also, investors who buy today would get a much smaller cash return of 2.9%. That is nearly double the current S&P 500 dividend return of about 1.6%. Nonetheless, today's investors will probably have to wait decades until they get their original investment back in dividend payouts. Furthermore, the previous dividend hike was about 5%, meaning that the dividend did not increase in real terms when compared with an 8% inflation rate.
2. Growth and valuation
The financials may also seem deceptively good at first. In the first quarter of 2022, revenue of $10.5 billion grew 16% year over year. Net income rose 28% to $2.8 billion on slower growth in selling, general, and administrative expenses and lower interest expenses.
Nonetheless, Coca-Cola struggled with revenue growth in recent years. While revenue surged by 17% in 2021, investors may forget that revenue peaked in 2012 at just over $48 billion. In 2021, the company brought in $38.7 billion in revenue, a drop of just over 19% over nine years.
And despite that decline, Coca-Cola's P/E ratio stands at around 26. That's higher than archrival Pepsico at 22 times earnings or Keurig Dr Pepper at a 21 P/E ratio, a factor that could dampen its appeal with industry investors.
3. Warren Buffett is a holder (not a buyer) of Coca-Cola stock today
Furthermore, investors should look closely at Buffett's activity in Coca-Cola stock, or rather, the lack of activity. Despite all the coverage of his Coca-Cola positions, Berkshire Hathaway has logged no trading activity in Coca-Cola stock since 1994.
Buffett bought Coca-Cola under different conditions. His first purchase of Coca-Cola stock took place in 1988, soon after the 1987 stock market crash. That year, he purchased almost 226.8 million split-adjusted shares for about $592.5 million. He raised that stake to a split-adjusted 373.6 million shares the next year and took his share count to a split-adjusted 400 million in 1994. But over the last 28 years, his share count has only changed when Coca-Cola stock split, meaning dividend collection was the extent of Buffett's activity in Coca-Cola during that time.
Making sense of Buffett's Coca-Cola position
Emulating Buffett's Coca-Cola investment appears to make little sense to new investors. While the 2.9% dividend yield is above average, several S&P 500 stocks and real estate investment trusts (REITs) offer higher yields on their payouts. Also, many dividend stocks sell at a lower P/E ratio than Coca-Cola and have not suffered long-term revenue declines.
If investors can find stocks that pay high-yielding, growing dividends at a discount, perhaps their payout returns will someday grow above 50%, but they should probably look elsewhere.
