Beverage conglomerate Coca-Cola (KO 0.72%) is one of Warren Buffett's most famous holdings -- he's owned the stock since buying it in the late 1980s, benefiting from decades of growth and dividends. It's a textbook example of the good things that can happen when you find a quality stock and let it work for you over time.
But the past isn't a sure-fire look into the future, and investors need to approach this old-time market favorite with a fresh perspective. Here is where Coca-Cola's business stands today and whether it makes sense for investors to buy the stock now.
Slow but steady growth
Coca-Cola is arguably the world's most dominant beverage company. It claims to have a 14% market share of all commercial beverage sales in developed markets and 6% in emerging markets. That may not seem like much, but this is a remarkable figure considering the vast universe of beverage products, including water, juice, tea, soda, and more.
Image source: Getty Images.
However, the company's revenue has contracted over the past decade, declining an average of just under 2% each year. Coca-Cola has had an eventful decade, including franchising its bottling operations, reducing revenue and increasing its profit margins. COVID-19 also created turbulence in the business because lockdowns on social events and venues curbed product demand.
Currently, management expects the business to grow revenue by 4% to 6% per year. This is refreshing after the past decade, though Coca-Cola is likely past its best growth years. It's a giant company with an almost $265 billion market cap.Investors should focus on management's ability to deliver this growth over the coming quarters and years.
Coca-Cola's dividend is legendary
The company's dividend is arguably its most famous investment trait. Longtime shareholders have enjoyed decades of dividend payments that increase every year. Coca-Cola is a Dividend King that has increased its payout for 60 consecutive years, one of the longest streaks of any public company.
Investors can get a dividend yield of just under 3% at the current share price, which can either be money in your pocket or reinvested to buy more shares to earn more dividends! Yes, dividend reinvestment can turbocharge compounding.
KO Dividend data by YCharts.
Coca-Cola's dividend payout ratio has come down sharply as the business has performed better in recent years. Now at 64% of cash flow, management can not only easily afford the payout, but it can retain some flexibility in how it spends its cash flow. Management recently announced that it would begin buying back its stock again in 2022, which helps grow earnings-per-share (EPS) by removing shares of stock from the market.
Improving financials
Coca-Cola left the bottling business and became a seller of drink concentrates, which cost much less money to produce. It now converts more revenue into free cash flow (FCF) than before, roughly $0.29 of every sales dollar.
KO Free Cash Flow (% of Annual Revenues) data by YCharts.
FCF has increased, totaling $11.2 billion over the past 12 months, which has helped management strengthen its financials. The company now has $9.6 billion in cash and equivalents on the balance sheet, which gives it more flexibility. This, plus a reduced dividend payout ratio, should help investors feel comfortable with the dividend's safety.
Is the stock a buy today?
The stock itself has dramatically underperformed the S&P 500 index over the past decade. Not factoring in dividends, Coca-Cola is up roughly 70% to 210% for the index. As I mentioned, the company has gone through some changes over the past decade, shedding its bottling business and then dealing with the pandemic.
Moving forward, the market could come to appreciate the improving FCF that Coca-Cola is producing. The stock trades at a price-to-earnings (P/E) ratio of 25,just slightly below its decade average P/E of 26.
Coca-Cola's reputation seems to earn it a slight bump in its valuation, but with management targeting high-single-digit EPS growth over the long-term, it's hard to see room for its valuation to move much higher from here.
If the company grows at the pace management is hoping for, investors can expect total returns in the 10% to 12% range based on EPS growth and a 3% dividend yield. In other words, Coca-Cola is a slow and steady stock that seems poised to do what it's already been doing for decades. If you're satisfied with that, Coca-Cola could be a fine addition to a long-term portfolio.
Justin Pope has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
