Coca-Cola (KO) is an established brand with a track record for paying dividends that dates back to 1893. Such a track record, along with the longtime ownership position of Warren Buffett's Berkshire Hathaway, still draws interest in the stock, particularly from dividend investors.
But despite the company's reputation, investors may want to think twice about rushing into the stock. Before opening a position, they should carefully consider three factors that make it more of a hold than a buy.
1. Warren Buffett's position is of little relevance to today's investors
Admittedly, the first reason may make little sense on the surface. Coca-Cola first became a Warren Buffett investment in 1988, adding shares the next year and in 1994. Its 400 million shares amount to an ownership stake of around 9%.
However, Berkshire last added shares 29 years ago, and investors should contemplate that inaction. The likely reason Berkshire sticks with Coca-Cola is its generous payout. At an annual dividend of $1.84 per share, Buffett's company will earn $736 million in cash this year from an original investment of $1.3 billion, a 57% return. Since the Dividend King has hiked the dividend for 61 straight years, Berkshire has little reason to walk away from that income stream.
In contrast, investors who buy today earn a dividend yield of around 3%. That's more than the 1.6% one will make from the S&P 500, but it may not compensate for the other issues investors face with the stock.
2. Coca-Cola stock is expensive
Another possible message Buffett has telegraphed by not buying Coca-Cola in 29 years relates to the stock's valuation. Despite lackluster stock price growth, the price-to-earnings (P/E) ratio stands at about 27. Interestingly, that compares well to peers like PepsiCo, Keurig Dr Pepper, and Monster Beverage, which all sell at higher earnings multiples.
KO PE Ratio data by YCharts
But is it worth that valuation? The 12% increase in consolidated net income for Coca-Cola in the first quarter of 2023 may make that earnings multiple seem reasonable. But considering that profits fell by 2% in 2022, its valuation looks elevated.
That also does not consider the stock's performance. Over the last 10 years, the S&P 500 has dramatically outperformed the stock, making it unlikely growth investors will take an interest. This was not the case when Buffett and his team bought the stock in the last century. And considering it beat the S&P 500 until the middle of the previous decade, it is unquestionably a winner for Buffett and other long-term investors.
3. Investors may overlook its dividend challenges
Additionally, despite the dividend's track record, it may be in more trouble than one might think. Indeed, the company hiked the dividend by nearly 5% in February, or $0.08 per share annually. This is consistent with the recent past, as it has increased the payout by that same amount in five of the last seven years.
Nonetheless, Coca-Cola reported a negative free cash flow of about $120 million in Q1. In 2022, the dividend cost the company $7.6 billion, 80% of its yearly free cash flow of $9.5 billion. This makes the payout a tremendous burden and leaves Coca-Cola with little money to invest in the company or buy back shares.
Admittedly, Coca-Cola is unlikely to walk away from a streak of dividend increases spanning over six decades. While it could cut the payout, ending yearly dividend hikes could cause severe reputational damage to the stock.
But if financial conditions don't improve, Coca-Cola could resort to cutting the amount of the payout hikes, increasing dividends just enough to maintain the Dividend King status. Such a move will probably not devastate the stock, but it may leave prospective income investors questioning whether this is a suitable dividend stock for them.
Stand pat on Coca-Cola stock
Considering its condition, investors likely want to treat Coca-Cola as a hold. For long-term investors like Buffett, it makes sense to keep collecting on its massive dividend return.
However, the beverage stock is expensive, and financial conditions could dramatically slow the payout hikes. Investors should also remember that Buffett has not bought any shares in nearly three decades, a factor to keep in mind when looking for dividend income.
