Coca-Cola (KO -0.46%) is undoubtedly one of the most powerful, well-recognized consumer brands in the world. And this is precisely why Berkshire Hathaway, the conglomerate headed by Warren Buffett, has owned shares in the company since 1988.
The Oracle of Omaha certainly likes Coca-Cola's durability as a business. And that helps explain why the beverage stock currently makes up under 7% of Berkshire's equities portfolio. It's the fourth-largest holding behind Apple, Bank of America, and American Express.
Perhaps the most important reason Buffett still loves Coca-Cola is because of the huge amounts of passive income that it spits out. Let's take a closer look.
A massive passive income stream
Berkshire currently owns 400 million shares of Coca-Cola. This means that on an annualized basis, Warren Buffett's company generates $736 million in dividend income from the beverage giant. That is a huge passive income stream that likely explains why Buffett isn't exiting the position.
Coca-Cola has long focused on returning capital to shareholders through these payouts, which now sit at $0.46 per share each quarter. The business has raised dividends in 61 straight years, easily making it one of the best companies in this regard.
Positive traits
It's not difficult to find reasons to appreciate Coca-Cola's business. For starters, this is an incredibly profitable enterprise. In the last 10 years, the company's operating margin averaged a stellar 25.9%. And through the first nine months of 2023, Coca-Cola generated $7.9 billion of free cash flow, which directly helps to fund dividend payments.
And as noted, the company has one of the strongest brands around. This helps it maintain top consumer mindshare across the world, reducing the chances of Coca-Cola ever being disrupted from the position it has in the industry.
This has created a scenario in which the company can flex its pricing power, which might be the characteristic Buffett appreciates the most. In the most recent quarter, Coca-Cola's net revenue increased by 8% year over year, driven primarily by pricing increases. This proves that consumers aren't going to switch to competing brands to save some money.
That adds to the stability of this company to continue producing healthy financial results no matter what the macroeconomic environment looks like. The fact that Coca-Cola is a mature, stable operation means there is really no chance that the dividend is ever in trouble of being eliminated. Moreover, the business is in a position to keep raising the payouts in the decades ahead.
Is Coca-Cola stock a buy?
Just because Warren Buffett, arguably the greatest investor ever, has a sizable stake in Coca-Cola doesn't automatically mean that you should too, even if the valuation is below the stock's trailing-five-year average. As of this writing, shares trade at a price-to-earnings ratio of 24.3.
But before rushing to buy the stock, consider Coca-Cola's growth potential. In the last 10 years, from Q3 2013 to Q3 2023, sales were flat. To be clear, this is a low-growth business, which might turn off some investors. Consequently, the valuation might be too steep, given that Coca-Cola is a very mature enterprise.
Additionally, just look at the stock's track record. In the last five years, if we include dividends, Coca-Cola has returned 50% to shareholders. By simply buying an S&P 500 index fund, you would have achieved a 102% gain during the same time frame. I don't think there's any reason to believe this kind of underperformance of the benchmark won't be the case going forward.
While Coca-Cola gives Buffett a huge passive income stream, I don't think it's a smart stock to buy right now for long-term investors.