It's curious. While no investor disputes that The Coca-Cola Company (KO 0.26%) is a stalwart, few would argue it's a growth stock either. Last quarter's modest revenue growth of 8% is better than its historical average, with most of that progress stemming from price increases rather than higher case volume.
And yet, with the shares trading at some 22 times trailing earnings and 19 times its forward-looking profits, Coca-Cola is priced more like a growth stock and less like the value name it actually is. What gives?
There's actually a perfectly sound reason the beverage giant's shares are valued at such a premium. If you're interested in owning it, don't let its steep price deter you. Here's why.
It isn't the company you think it is -- it's more
You know the company, of course. Coca-Cola is one of the world's most recognized brand names, and the biggest in terms of carbonated beverages. Yet, the company is so much more than its namesake cola. It is also parent to Dasani water, Gold Peak tea, Minute Maid juice, and Powerade, just to name a few brands. It's got something to sell to someone in nearly all situations.
The depth and width of its product assortment is evident in its results -- its bottom line, in particular. Although it can be erratic from one year to the next, in 10-year timeframes, the company grows profits. And this track record is likely to persist into the indefinite future, particularly in light of Coca-Cola's recent strategic shift.
KO Net Income (TTM) data by YCharts
As a customer, you can't tell the difference. But Coca-Cola does very little bottling of its own products anymore. It's been selling these operations to local bottlers for the past several years so it could better focus on what it does best. That's building up its brand names, and collecting royalty and licensing revenue from bottlers doing the bulk of product production.
Costs associated with this restructuring account for most of the profit decline seen between 2014 and 2017. In the long run, though, this model is far more fruitful for Coca-Cola than being in the bottling business is. While it ultimately means less revenue, it also means more profits. That's because the royalty and brand-licensing business is higher-margin than bottling. This has particularly been the case of late, as the bottlers themselves are bearing the brunt of higher commodity and logistics costs.
It's the company's powerful brand names -- and how they're marketed -- that make Coke's stock worth more than 20 times its trailing 12-month profits.
What's in a name? A lot, actually.
Most consumer-facing companies advertise, and plenty of consumer-facing companies have been around for a long time. Few companies have been around for as long as Coca-Cola has, however, and fewer still have promoted their products as effectively for as long as Coke has.
So what? In that most people are already familiar with the brand itself, Coca-Cola doesn't first need to teach them what its products are -- they already know. This familiarity allows the company to do more of the deeper marketing intended to appeal to customers' emotions.
For example, its "Share a Coke" campaign that launched in 2011 focused very little on the product, and was instead intended "to create a more personal relationship with consumers and inspire shared moments of happiness." And the strategy worked.
This approach is apt to continue working too, using the brand's long history and ability to remind people of a more civil, less noisy era when its beverages were a component of good memories.
The end result of this long-lived brand awareness and the emotionally charged marketing it facilitates is loyalty that borders on being freakish. Take last quarter's revenue growth as an example. Sales were up 8% year over year, but volume (the total amount of beverage sold to customers) was only up 2%. The rest of that growth came from the average 9% increase in prices -- prices that people willingly paid. It's a testament to customers' brand loyalty.
To this end, advertising analytics outfit DesignRush reports that Coca-Cola boasts the fifth-most loyal customers in the United States.Coca-Cola just has to keep pressing the right marketing buttons.
Just buy Coca-Cola stock already
There are other powerful brand names out there, to be sure. For instance, a wide swath of Apple's customers are incredibly loyal. Consumer Intelligence Research Partners reports 94% of current iPhone owners are likely to buy another iPhone in the future. People with multiple streaming video services say they're least likely to cancel their subscription to Netflix.
No other company has fostered the sort of brand loyalty that The Coca-Cola Company has for as long as it has done so, however. That's why it's such a revenue and earnings juggernaut even in tough times -- shareholders don't have to worry about it being unable to perform, even if it's not growing at double-digit growth rates. That's why its stock commands a premium valuation.
KO PE Ratio data by YCharts
Bottom line? Coca-Cola has proven it's unstoppable when given enough time to adapt to changes in the market environment. You can tuck it away in your portfolio for a lifetime and rest easy. That isn't something which can be said of very many companies.
The kicker: Despite the frothy valuation, Coca-Cola's 3.4% dividend yield is well above the S&P 500's 1.6%. That dividend has also grown more than 60% in the past 10 years, outpacing marketwide dividend growth over that timeframe. Plus, the company has raised the dividend for 61 years in a row now.
