Costco (COST 0.16%), Walmart (WMT 0.60%), and Coca-Cola (KO +0.04%) are among the most popular blue chip stocks in the consumer sector. Coca-Cola is also a longtime Warren Buffett stock.
Buffett, during his tenure as CEO of Berkshire Hathaway, may have occasionally held Costco and Walmart shares within the Berkshire stock portfolio, but Berkshire's investment in Coca-Cola spans nearly 40 years. Shares in the soft drink maker remain one of Berkshire's top stock holdings.
Buffett's seal of approval notwithstanding, it's well worth acknowledging that Coca-Cola has underperformed compared to Costco and Walmart. Since January 2006, Walmart is up by nearly eightfold. Costco is up by nearly eighteenfold over this same timeframe. Coca-Cola, however? Shares are up by a relatively modest 240%.
Yet while the aforementioned retailer stocks have outpaced Coca-Cola's performance by a wide margin, it's possible that past performance is not indicative of future results. That is, over the next 20 years, Coca-Cola could outperform Costco and Walmart in term of stock total returns. Here's why.
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High valuation means high expectations
Higher levels of earnings growth partially explain why Costco and Walmart have outperformed Coca-Cola since 2006, but that's not the whole story. Valuation expansion is another factor. During this time, both of these top-performing blue chip stocks have experienced a massive increase in their respective forward valuations.
NASDAQ: COST
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As a result, Costco currently trades for around 46.5 times forward earnings. Walmart trades for nearly 39 times forward earnings. Coca-Cola, however, trades at a much lower 21.5 times forward earnings. Again, growth rates play a big role in this valuation discrepancy. It's not as if Coca-Cola itself is necessarily deserving of a higher forward price-to-earnings ratio.
NASDAQ: WMT
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However, for Costco and Walmart, besides being indicative of strong recent growth, their respective rich valuations underscore how investors expect both companies to grow earnings at an above-average pace in the years ahead.
If, at any point in the two decades ahead, either company experiences a growth hiccup -- or, worse, a permanent slowdown -- expect the market to de-rate their respective shares accordingly.
NYSE: KO
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Why this could mean stronger, steadier gains for Coca-Cola
Long-term sell-side analyst forecasts for Costco and Walmart call for earnings growth of around 10%. Yet, while such growth may be enough to sustain their valuations, if the growth falls short, Costco's and Walmart's respective valuations could drift significantly lower.
Historically, Costco's valuation was more similar to Coca-Cola's current valuation. A decade ago, Walmart traded at a forward multiple in the low to mid-teens. Don't get me wrong. I'm not saying that either of these stocks could generate negative returns going forward. What I am saying is that both stocks are at risk of becoming stagnant, stuck "growing into their valuation."
In contrast, forecasts for Coca-Cola are much more conservative. If the company can sustain high single-digit earnings growth, shares could continue to steadily climb higher.
Add in the stock's 2.9% dividend yield, and consider the likelihood that this Dividend King will continue to increase its cash payouts by around 4% to 5% annually. Put it all together, and it's not far-fetched to see Coca-Cola ending up being the stronger performer among consumer stocks. Hence, it's the one stock among these three I'd be most comfortable owning.
