Coca-Cola (KO -1.02%) stock is riding high following its second-quarter earnings report. The cola giant beat revenue and earnings estimates, and products like Diet Coke and Coke Zero delivered a particularly strong performance.
Nonetheless, a surface-level analysis of Coca-Cola versus archrival PepsiCo might persuade investors to choose the latter. After all, PepsiCo sells for a lower P/E ratio and its dividend yield is significantly higher. Also, even though Coca-Cola was one of Warren Buffett's most famous investments, Berkshire Hathaway has not purchased a single share since 1994.
Fortunately for Coca-Cola bulls, a surprising reason may keep investors in Coca-Cola stock.
Image source: Getty Images.
Why Coca-Cola is the beverage stock of choice
As previously mentioned, PepsiCo's 19 P/E ratio is well below Coca-Cola's earnings multiple of 27, a surprisingly high premium given the companies' similarities.
Also, PepsiCo's 4% dividend yield is well above Coca-Cola's return of 2.3%. Both stocks are Dividend Kings by virtue of having increased the dividend annually for more than 50 years. Thus, PepsiCo seems to have an advantage with income investors.
However, Coca-Cola stock has delivered higher overall returns despite those advantages. Moreover, this is not a temporary phenomenon. Thanks to a breakout in April, Coca-Cola's returns exceeded those of PepsiCo over the last year. Additionally, in nearly every time period going back to 1990, Coca-Cola has outperformed its archrival.
KO Total Return Level data by YCharts
Some subtle differences in Coca-Cola's business model may explain its outperformance. Unlike PepsiCo, Coca-Cola outsources all bottling, trucking, and distribution to third parties. That makes it a comparatively asset-light business, and without those expenses, it earns higher operating margins than PepsiCo.
Furthermore, despite its more than 200 brands, Coca-Cola remains exclusively a beverage business. In contrast, PepsiCo's ownership of food brands such as Frito-Lay and Quaker also places it in a business that has higher input costs.
Consumers have also turned against packaged foods in favor of more natural or organic options, which serves as another headwind that Coca-Cola does not face. In the minds of some investors, those advantages might justify Coca-Cola's higher premium.
NYSE: KO
Key Data Points
Choosing Coca-Cola stock
Coca-Cola has attracted a premium valuation amid a comparatively asset-light business model that generates higher margins.
Admittedly, income-oriented investors should probably choose PepsiCo for its much higher dividend yield. Also, Coca-Cola trades at its steepest premium to PepsiCo in years.
However, in my view, Coca-Cola stock justifies that higher valuation. Ultimately, overall returns are what are important to most investors, and Coca-Cola has met that criterion nearly every time period.
Moreover, Coca-Cola's consistently higher margins make it less likely PepsiCo is going to fully close that valuation gap. Thus, investors should expect that outperformance to continue.
