Hello, this is Div4Son.

Coca Cola (KO) is one company that showed up on my April screener. http://div4son.blogspot.com/2015/04/my-screen-for-april-2015.html. I currently have a single position in KO, and wouldn't mind adding more. However, it is useful to repeat the due-diligence process when you buy (or sell) any stocks. Therefore, this article summarizes my thought process about KO.

My basic strategy is:

My basic strategy is:

Good quality + high yield + high growth (+ time & patience)

This strategy follows the same framework as the SBI book.

**About Coca Cola (KO)**

Coca-Cola is the world's largest producer of soft drinks, as well as the world's biggest producer of juice and juice-related products. They are sold in more than 200 countries with more than 500 brands all parts of the world.

They also sell other beverage products included water and enhanced water brands. The company's business encompasses the production and sale of soft drink and non-carbonated beverage concentrates and syrups. These products are sold to the company's authorized independent and company-owned bottling/canning operations, and fountain wholesalers. They have recently started a partnership with partner Keurig Green Mountain.

Competitors - PepsiCo, Nestle, Kraft Foods, Unilever, and Dr. Pepper Snapple Group.

__Summary of Criteria__KO April 2015 | Area | Criteria | CheckList | Comment |

Quality Company
| Dividend Growth | >5 years | Yes | 53 years |

ROE/EPS/Op Margin | Stable | Yes | See Chart | |

Long term Avg Growth | Stable | Yes | See Chart ~6-8% | |

Short term Avg Growth | Stable | No | See Chart Negative YOY growth 2014 | |

FCF over Dividends | Yes | Yes | See Chart | |

M* Moat | Wide Moat | Yes | M* Wide | |

M* & S&P Credit Rating | > BBB+ | Yes | M* AA- | |

Cash to Debt & Interest Coverage, Debt to Equity | Cash Debt >1 or Interest Coverage > 5 Debt to Equity <.5 | No Debt/Equity >50% | Cash to Debt 0.52, Interest Coverage 20.10 Debt to Equity 63% | |

M* & S&P Stars | > 3 Stars for both | Yes | M* 3 Stars S&P CapIQ 3 Stars S&P A quality rating | |

Payout Ratio | <60% | No | 76% | |

Dividend Growth
& Yield | Dividend Yield | >3% | Yes | 3.20% |

Dividend Growth | >5% | Yes | 5Y CAGR 8.3% 2015 YOY 8.2% | |

Chowder | >12% | No | 11.50% | |

Valuation
| Yield/Avg Yield | >1.1 | Yes | 1.14 |

Dividend Yield Theory Mid Point | Below Mid Point | Yes | Mid Point 44.88; Low Point 37.4 | |

DRRM | ~10% | Yes | Assuming 7% growth; projected return=9.65% | |

M* Estimate | <M* est | Yes | M* 43 | |

S&P Estimate | < S&P cap IQ est | Yes | S&P Cap IQ 45 |

Data from M*, gurufocus, yahoo finance, S&P CapitalIQ, David Fish CCC list

__Quality analysis__**Years of Dividend raises**

KO has 53 years of dividend raises. This is a good indication of continued dividend raises.

**Stability of key metrics**

These ratios provide an indication of how wide the moat is. I am looking for overall stability (or even better - growth). If the ratios decline year over year, then this is an indication of moat reduction. I also compare these ratios with other companies within the same sectors.

As you can see, KO is showing stability in these ratios. There is only a minor decline by ROE & Operating Margin in the 20% range is an healthy indication of wide moat.

**Average growth**

Here, I look for the stability of growth indicators over ten years.

The 10 year average growth is reasonable with mean of 6-8%.

**Free cash flow over dividends**

I use the free cash flow per share and compare this with dividends per share. FCF should cover the dividends. As you can see KO's FCF easily covers the dividend YoY.

**M* Moat**

I simply use the moat indicator from M*to validate my findings. KO has a wide moat due to the brand image, economy of scale and distribution network.

**Credit rating**

Here, I look for companies with credit rating of BBB+. Just like banks wanting good credit from you when you apply for a loan, you want companies which are stable from a credit perspective.

KO's credit rating from M* is AA-.

**Debt**

I look at the debt to equity ratio (<50) and cash to debt and interest coverage. Sometimes, a little good debt is good to push a business, but too much debt can be crippling.

However, the Debt/Equity is 63%. Moreover, the 10 year plot shows an increasing Debt/Equity ratio.

This is something to monitor for future years.

**M* and S&P capital IQ rating**

I am looking for 3 stars and above from either. A four star is a bonus.

M* gives KO 3 Stars and S&P CapIQ gives 3 Stars with as A quality rating.

M* gives KO 3 Stars and S&P CapIQ gives 3 Stars with as A quality rating.

__Dividend Yield and growth__
Dividend yield is 3.20%.

Chowder is 11.5%

Overall, KO's chowder is close to 12%. It is better to be over 12% - but 11.5% is not bad.

This is something to monitor in the next couple of years.

Overall, KO's chowder is close to 12%. It is better to be over 12% - but 11.5% is not bad.

__Payout Ratio__
The payout ratio is around 75% - much higher than my target of 60%. However, FCF should easily cover the dividends.

This is something to monitor in the next couple of years.

__Value analysis__**Average yield**

The current yield per average yield for 5 years ratio is greater than 1.14. I use this as a quick indicator for fair valuation (if greater than 1.1).

**Dividend yield theory mid point**

Using the dividend yield theory spreadsheet (based on the Dividends Don't Lie book), I calculate the mid and high points for the yield, from which I derive the price.

Note: You can get the spreadsheet at: http://div4son.blogspot.com/2015/03/dividend-yield-theory-spreadsheet.html

Note: You can get the spreadsheet at: http://div4son.blogspot.com/2015/03/dividend-yield-theory-spreadsheet.html

Based on the price/yield chart, I estimate the high/low yields to be 3.5%/2.5% respectively.

High Price: | 52.36 |

Mid Price: | 44.88 |

Low Price: | 37.40 |

I am okay to buy great companies at reasonable prices and I think the price is reasonable for KO. Anything near 40 is good.

**Dividend Drill Return Model**

Also, using the dividend play book DDRM model per the Dividend Playbook, I try to estimate the total return. Using the growth information above 6-8%, I use a conservative growth rate of 7%.

DDRM | |

Dividend Rate ($) | 1.31 |

Divided by: share price | 40.91 |

Current yield (%) | 3.20 |

Core Growth Estimate (%) | 7.00 |

Divided by: ROE (%) | 22.08 |

Multiplied by: EPS ($) | 1.59 |

Cost of Growth (%) | 0.50 |

Earnings per Share ($) | 1.59 |

Minus: Dividend | 1.31 |

Minus: Cost of Growth | 0.50 |

Funding Gap ($) | -0.22 |

Divided by: Share Price ($) | 40.91 |

Share Change (%) | -0.55 |

Core Growth (%) | 7.00 |

Plus: Share Change (%) | -0.55 |

Total Dividend Growth (%) | 6.45 |

Plus: Dividend Yield (%) | 3.20 |

Projected Total Return (%) | 9.65 |

I estimate the projected return to be at 9.65%. I am happy with anything around 10%.

Rearranging the numbers using calculated div growth%:

Rearranging the numbers using calculated div growth%:

Dividend Rate ($) | 1.31 |

Required Return (%) | 10.00 |

Growth (%) | 6.45 |

Price | 36.92 |

Dividend Rate ($) | 1.31 |

Required Return (%) | 10.00 |

Growth (%) | 7.00 |

Price | 43.64 |

So, the price range is around 37 - 44 - in line with my low - mid price points.

**M* and S&P valuations**

Morningstar gives trow a fair value of 43. S&P capIQ gives a fair value if 45. Therefore, with a current price around 40.5, KO is reasonably priced.

**Risks**

- Cola consumption especially Diet Coke is decreasing.
- Earnings growth is reducing - see EPS growth graph above.
- KO is not as diversified as Pepsi with the snacks business etc.

--

KO didn't meet all my criteria for stock selection. Moreover, the payout ratio is higher (75%) than previous years. It's earning per share is decreasing this couple of years and it's debt to equity is increasing (over the .5 point).

However, from a long term perspective (20+ years), I think KO will continue to pay a decent dividend as it weathers through short term issues. It is a Dividend Champion after all. Moreover, if I reinvest all my dividends, and continue to add when KO is reasonably valued, then I should be okay.

I bought 42 shares of KO on April 27 at 40.81. This adds to my existing 40 shares (+ dividend reinvestment). My forward dividends for KO is around $108.

Div4son

Disclosure - long KO

Div4Son,

ReplyDeletethanks for your documenting your clear structured and methodical approach! I can learn a lot from you. At the moment I have no standardized way of selecting a stock. I will do something similar in the future. Thank you! (And thanks for fixing the comments!)

Best of luck to you!

DivRider, thanks for commenting. I am still learning and there is still a lot to learn. For example, I am still learning to analyze REITs and my metrics in my spreadsheet are not so reliable anymore to determine quality as well as valuation. When I figure something out, I will be happy to share!

DeleteD4s

you write: Rearranging the numbers using calculated div growth%:

ReplyDeleteWhat's the math that gives you the range of 37-44?

Edward

DeleteThanks for your comment. The math is based on the Gordon Growth Model.

Present Value = Current Income/(Required Return - Growth Rate)

Current Income is the dividend income. My required return is 10%. The growth rate is mentioned above based on DDRM or just my est. Growth.

Hope this helps.Give me a shout if you need clarification.

D4s

Alright... that makes sense! However, how does Gordon Growth deal with an expected growth at like 15% but required return being only 10%.... Take apple... it pays $2.08 in dividend... Growth rate (depending on how you calculate could be as high as 15%... 2.08 / (10-15)?

DeleteEdward,

DeleteYou are right. The model breaks down if the company does not pay a dividend or the growth rate exceeds the rate of return.

If I wanted to analyze AAPL, I would have to reverse engineer the DDRM to get the price based on the required return. Another project for me :)

Of course, this is one piece of the valuation puzzle. I would also use the yield theory if the history is long enough or the PE analysis in conjunction with the M* and S&P capital estimates.

D4s