Is Coke Being Valued Like a U.S. Treasury?

I’m still surprised by the high price that Coca-Cola ($KO) is fetching. The stock closed yesterday at $37.74 which isn’t far from a 52-week high. I just don’t see how that’s justified.

Let’s look at some numbers. Earlier this week, the company reported Q3 earnings of 51 cents per share which matched Wall Street’s estimate. As we’ve come to expect with companies that do a lot of business outside the U.S., the strong dollar took a bite out of Coke’s profits. Revenue rose only 1% to $12.34 billion which was $70 million shy of Wall Street’s estimate. The rising greenback knocked five percentage points off revenue growth and seven points off operating income growth. That’s unfortunate but I doubt that headwind will last.

Still, Coke is going for 17.1 times next year’s earnings estimate. I just don’t see how Coke can justify an above-market premium in an environment like this. Coke’s earnings growth for the next five years is estimated to be 7.43% which is 2.75% less than what’s expected of the S&P 500.

The current quarterly dividend is 25.5 cents per share which makes the payout ratio exactly 50%. For the S&P 500, the payout ratio is running close to 30%. Even with that high payout ratio, Coke’s dividend only comes to 2.7%. Many high-quality stocks pay yield much higher than that right now.

By my math, Coke’s fair value is close to $26. Perhaps investors see the Coke brand as similar to a U.S. Treasury. After all, there aren’t many better representatives of American capitalism than Coca-Cola. I think this way of thinking is a huge mistake, but I can see how investors can reason a 17 P/E for Coke in a world where a five-year Treasury has a P/E of 130.

The major mispricing in the market right now is that investors are vastly over-paying for security, and they are under-paying for risk. I think this will slowly unwind—in fact, it’s already started. That explains why U.S. stocks have advanced this year even as earnings estimates have come down. The market is slowly reverting to normal.

Posted by on October 18th, 2012 at 11:19 am


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