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Coca-Cola: Current Dividend Yield Is Too Low
Stock Analysis & Ideas

Coca-Cola: Current Dividend Yield Is Too Low

Coca-Cola (KO) is a widely recognized beverage company that has been around since 1892. We are neutral on the stock.

Dividends

Recently, we wrote an article on Monster Beverage (MNST) where we mentioned that it was one of the fastest stocks in history to 100x in stock price. Although Coca-Cola has been a great investment for long-term shareholders like Warren Buffet, it didn’t see success as fast as MNST did.

In fact, it took 29.3 years for Coca-Cola to see 100x returns versus 9.5 years for Monster. However, Coca-Cola is now a mature company and investors don’t buy it for the growth. Instead, the company is a reliable dividend stock with low single-digit growth.

Coca-Cola currently has a 2.73% dividend yield, which is above the sector average of 1.51%. When taking a look at its LTM free cash flow figure of $11.7 billion, its $9 billion LTM dividend payment looks safe.

However, it is important to note that this is not the case when looking at analysts’ estimates for future free cash flow. Analysts expect free cash flow of $7.4 billion for Fiscal Year 2021 and $8.4 billion for Fiscal Year 2022. Thus, a $9-billion dividend payment may not be sustainable.

Taking a look at its historical dividend payments, we can see that its yield range has trended downwards in the past several years.

At 2.73%, the company’s dividend is near the low end of its range, implying that the stock price is trading at a premium relative to the yields investors have seen in the past.

Economic Spread

A great metric we like to look at is called the economic spread. We like this metric because it is a quick way of looking at management’s efficiency at allocating capital. It is defined as follows:

Economic Spread = Return on Invested Capital – Weighted Average Cost of Capital

Essentially, if the return on invested capital is greater than the cost of that same capital, then the company is creating value for its shareholders through well-thought-out projects. Otherwise, the company is destroying value and would be better off simply investing money into risk-free bonds.

For Coca-Cola, the economic spread is a follows:

Economic Spread = 13.7% – 7%
Economic Spread = 6.7%

As a result, the company is creating value for its shareholders, implying that management is efficiently allocating capital. Interestingly, this number is similar to Coca-Cola’s expected earnings growth over the next three years.

Wall Street’s Take

Turning to Wall Street, Coca-Cola has a Strong Buy consensus rating, based on nine Buys and three Holds assigned in the past three months. The average Coca-Cola price target of $63.92 implies 4.9% upside potential.

Analyst price targets range from a low of $55 per share to a high of $70 per share.

Final Thoughts

Coca-Cola is an iconic brand that is recognized everywhere around the world. Its dominance of the beverage industry is the result of over a century of work.

However, investors need to consider a few things before investing in Coca-Cola. The first is that its current dividend yield is near a historical low, which implies the stock is relatively overvalued. In addition, its LTM dividend payment may be pushing the envelope based on analysts’ estimates of future free cash flow.

Lastly, the consensus estimate suggests that there isn’t much upside potential left for the stock. As a result, we believe there may be better opportunities for dividend investors.

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