Is there anyone in the world who does not know of The Coca-Cola Company (KO 0.49%)? Established in 1886, it has evolved from a local soda fountain syrup to a global beverage company famous for its iconic branding and distinctive taste. The stock went public in 1919, rewarded shareholders handsomely throughout the century, and started paying dividends in 1964.
Yet, recent times have been a bit frustrating for shareholders. Although the company is the global beverage leader, its stock has struggled over the past five years, severely underperforming the overall market. So, let's examine the stock and Coca-Cola's recent key financial metrics to evaluate whether it should be considered a buy, sell, or hold.
Coca-Cola is a favorite of Warren Buffett
Coca-Cola has long been a favorite stock of Warren Buffett, who first bought shares through Berkshire Hathaway in 1988 and then over the next seven years for a total of $1.3 billion. Despite not reinvesting Coca-Cola's dividends, which amounted to a noteworthy $704 million in 2022 alone, Berkshire's ownership stake has risen.
This is as a result of Coca-Cola's strategic stock repurchases. To illustrate, Berkshire's 400 million shares (split adjusted), representing a 7.8% ownership stake in 1994, have expanded to 9.2% through share buybacks. Though Berkshire Hathaway hasn't acquired more shares since 1994, Buffett has emphatically declared that he will never sell a single share of the stock.
Coca-Cola is shareholder-friendly
Berkshire Hathaway's investment illustrates that Coca-Cola is dedicated to returning capital to shareholders. It has paid and raised its dividend annually for 61 consecutive years. Today, the beverage behemoth pays a quarterly dividend of $0.46 per share, representing an impressive annual yield of roughly 3.2%.
And management has lowered the company's outstanding share count by 16% since 1994, which, as exemplified in Berkshire's case, is a tax-efficient way of increasing a shareholder's ownership stake.
Image source: Getty Images.
What could go wrong for Coca-Cola?
Before considering any investment, an investor should consider the bear case to determine possible risks. For Coca-Cola, the company's commitment to returning capital to shareholders is also one of its most significant risks.
For dividend-paying companies like Coca-Cola, the payout ratio (annual dividend payments divided by annual earnings) is an important metric to monitor to ensure the company can afford to maintain and potentially raise its payout. Generally, any payout ratio higher than 75% should give an investor pause. With a payout ratio of about 72%, Coca-Cola could struggle to raise its dividend if earnings stagnate.
The company has lowered its share count over the past few decades, but management has struggled to make meaningful inroads in recent years. That's because Coca-Cola's current share-repurchase program is aimed at offsetting dilution resulting from employee stock-based compensation plans rather than previous programs that succeeded in drastically lowering its outstanding shares.
To illustrate, the outstanding share count is actually up 1.3% over the past five years, but management lowered it by 0.1% in 2023 with its new goal. All together, Coca-Cola will be spending roughly $8 billion on dividends in 2023 and has already allocated $1 billion in share repurchases through September for a total of at least $9 billion.
Considering that the company expects to generate $9.5 billion in free cash flow for 2023, there isn't much room left for paying down its $25 billion in net debt (total debt minus cash and cash equivalents), which is becoming more expensive to service as interest rates stay elevated.
And the company has an unsettled $3.4 billion tax debt for the years 2007 to 2009, as the beverage company allegedly limited its royalty income in the U.S. The ongoing litigation has it disputing the Internal Revenue Service's action and the latest decision by the U.S. Tax Court, calling the amended calculation methodology "unconstitutional."
What could go right for Coca-Cola?
For mature companies like Coca-Cola, a revenue plateau is inevitable. The company's high-water mark occurred in 2012, with $48 billion in net revenue. That key metric was in free fall until 2022 and now finally appears to be reversing course.
Specifically, the beverage company's revenue bottomed out in 2020 at $33 billion, before increasing to $38.6 billion in 2021 and $43 billion in 2022.
Management expects its organic revenue (excluding currency fluctuations and recent acquisitions, divestitures, and structural changes) to grow 10% to 11% in 2023 compared to 2022. For its most recently reported quarter, it pointed to a 2% volume increase and price hikes for the strong growth.
KO revenue (annual), data by YCharts.
Earnings per share (EPS) also appear to be growing again. The company generated a diluted EPS of $2.01 through the first three quarters of 2023, up 17% year over year. And management expects EPS to grow 13% to 14% on a currency-neutral basis for the full-year 2023 compared to 2022.
Is Coca-Cola a buy, sell, or hold?
Nonetheless, the stock has some red flags, as outlined here, which is perhaps why Berkshire Hathaway hasn't purchased anymore shares since 1994. All in all, Coca-Cola is still a good stock to hold for dividend-seeking investors since management will likely continue to prioritize returning capital to shareholders, given its history.
