A moment of truth. If I were able to buy only one stock, Inside Value selection Coca-Cola (NYSE:KO) would not be it. But the truth is, sometimes stocks are purely a good strategic fit within a portfolio, and Coke might be just what the doctor ordered.
If we held Coke on its own, we might assess its performance according to its average returns and its standard deviation, a statistic that measures the variation of returns from the average over a given period. As I said, there are probably better stocks out there if you were holding only one.
Within a portfolio, however, things change. There are some stocks that are able to lower the overall standard deviation (a proxy for risk) of a well-diversified portfolio. Ideally, such a stock would go up while the others go down, and vice versa. There's actually a statistic called "covariance," which measures how stocks move in relation to one another.
Coke is a perfect example of a stock that can likely reduce risk within your portfolio. While it is not likely to offer the highest expected returns, it does hedge a unique set of risks. Think of a portfolio like a basketball team; a diverse set of skills and functionalities is needed to make a truly great team. Thus, let's consider Coke as a member of our portfolio, knowing it's not a Michael Jordan but maybe a Scottie Pippen or, lower down the ladder, a Craig Hodges. After all, we want the whole team (our portfolio) to prosper, not just a single player. As you read, take note as to whether or not your portfolio is subject to the risks that Coke might likely reduce.
Once in a while a first-class stock like Coke ripens. Coke is currently trading at a P/E of 22, not witnessed since the early 1990s. This is sweetened by the company's dodging a bullet from an SEC investigation and posting a magnificent Q1. Nevertheless, Coke has been in a slump compared with rival Pepsi (NYSE:PEP). Over the past five years, Pepsi was up nearly 50% while Coke was down almost 15%. CEO Neville Isdell, appointed in June 2004, is looking to play catch-up. The company has begun allotting more cash to marketing in an attempt to gain market share and further promote recognition of its brands. How else do you stick carbonated water and high-fructose corn syrup in a can and sell it for buck? Marketing!
With continued growth overseas, Coke has a world-renowned brand that is ready to be fully exploited in emerging markets such as China. Actually, Coke has been in China since 1979 and recently grew volumes there by 22% in 2004 through marketing initiatives. Coke collects revenues from around the world, which is itself another reason to welcome the company to your portfolio. Coke acts as a currency hedge in this day and age of a low dollar. As the world's markets ebb and flow, companies like Coke take the sting out of single market fluctuations. Carbonated syrup sold at a stronger euro or yuan repatriates with more gusto.
Let's pause for the obvious question: Why not Pepsi? In fact, I think there is room for both in a portfolio. My preference for Coke is due to timing. With its new leadership and increased focus on marketing, I feel Coke has more to gain in playing catch-up to Pepsi. Furthermore, Coke boasts a profit margin of 21.3% versus Pepsi's 14.4% (Pepsi has more lower-margin products under its umbrella). Its dividend yield is 2.5%, which matches most money markets and hedges current inflation. Pepsi pays out 1.7%.
Here then is a brief summary of why Coke might fit nicely into your portfolio: a historically low P/E; recent legal risks evaded; a far-reaching global business strategy; increasing exposure to emerging markets and foreign currencies; its management refocus; its collection of powerful brands; the ability to provide an inflation hedge; and healthy margins.
Alas, it is not likely that Coke will quadruple its revenues by Q2. If you yearn for the high potential returns of the likes of a Google or a Yahoo, by all means consider these in your research. But let's not forget the murky world of standard deviations and covariances and other mathematical ways of measuring risk. Or better yet, let's reconsider our basketball metaphor. There may come a day when these high-fliers have a bad season or a career-ending injury. Please do not ignore the importance of a good assist man. After all, would the Bulls have been so prolific without a true-blue supporting cast performing beside MJ? Might the record of the Washington Wizards during (an admittedly older) MJ's two seasons there offer us a clue?
Fool contributor Cliff Malings does not enjoy soft drinks of any type. But as a born-again fitness freak, he has guzzled a Dasani or two at runs and triathlons. Cliff does not own shares of any companies mentioned here.
