Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Coca-Cola (KO 0.31%) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.
What we're looking for
The graphs you're about to see tell Coke's story, and we'll be grading the quality of that story in several ways:
- Growth: Are profits, margins, and free cash flow all increasing?
- Valuation: Is share price growing in line with earnings per share?
- Opportunities: Is return on equity increasing while debt to equity declines?
- Dividends: Are dividends consistently growing in a sustainable way?
What the numbers tell you
Now, let's take a look at Coke's key statistics:
KO Total Return Price data by YCharts
|
Passing Criteria |
3-Year* Change |
Grade |
|---|---|---|
|
Revenue growth > 30% |
49.8% |
Pass |
|
Improving profit margin |
(22.6%) |
Fail |
|
Free cash flow growth > Net income growth |
13.7% vs. 15.9% |
Fail |
|
Improving EPS |
18.8% |
Pass |
|
Stock growth (+ 15%) < EPS growth |
76.2% vs. 18.8% |
Fail |
Source: YCharts. * Period begins at end of Q2 2010.
KO Return on Equity data by YCharts
|
Passing Criteria |
3-Year* Change |
Grade |
|---|---|---|
|
Improving return on equity |
(12.1%) |
Fail |
|
Declining debt to equity |
141.3% |
Fail |
|
Dividend growth > 25% |
27.3% |
Pass |
|
Free cash flow payout ratio < 50% |
59.5% |
Fail |
Source: YCharts. * Period begins at end of Q2 2010.
How we got here and where we're going
Coke puts together a rather underwhelming performance for such a rock-solid dividend payer, as it's only earned three out of nine possible passing grades. However, one of those failing grades happened due to the narrowest under-performance -- free cash flow has certainly grown along with net income, and could pull ahead over the next few quarters. Despite promising revenue growth, higher costs have put the pinch on Coke's profit margins, which has hampered it somewhat today. Let's dig a little deeper to see whether Coke can turn these issues around.
Coke reported a 3% decline in revenue in its latest quarter due to poor weather conditions in North America and in Europe, coupled with weak overall demand for sparkling beverages. Volumes declined by 4% for sparkling beverages in North America, but this was offset by a 5% growth in volume for the company's still beverage portfolio. Negative publicity surrounding the role of soft drinks in myriad health problems was also blamed for the weakness. To fight back, Coke came up with advertisements that shift the blame for "growing" health problems to a generalized consumption of excess calories, and not just soda. This seems a bit like a tobacco company blaming smoke-filled rooms for your lung disease, but a company that's painted as a villain has to do something to change the conversation.
PepsiCo (PEP -0.41%) CEO Indra Nooyi has condemned these statements, which are likely to create a backlash against the entire beverage industry. Over the past couple of years, Pepsi has been through a tough phase, as sales have declined, and market share has been lost to beverage rival Coke. Any advantage that Pepsi can seize in the cola (and beverage) wars will be hard won, but it's tough to see a winning strategy in one sugar-water vendor calling out the other for trying to evade responsibility for selling sugar water. At least the tobacco companies presented a united front when attacked -- and the beverage industry might still be forced to band together if public opinion sours to a great enough degree.
Coke understands the market's shifting trends as well as any company, and has thus been concentrating on still beverages, which have now reported 24 consecutive quarters of volume growth. The company's still beverage portfolio posted 10% growth last year and is expected to grow at a similar rate this year. Though it is trying to increase its still beverage offerings, Coke still remains with a major concentration on sparkling sodas, and is hardly abandoning that segment to mitigate the stigma of health issues surrounding soda, Coke has been testing moderate-calorie versions of Fanta and Sprite sweetened with stevia. If these new varieties work, expect to see a multi-brand rollout of stevia sodas.
Putting the pieces together
Today, Coke has some of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.
