Time To Sell Coca-Cola?

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I know that many people just reading the title of this post might immediately dismiss me as crazy. However, even some of the greatest investments change with time and need to be reevaluated. The question of whether to sell Coca-Cola (NYSE: KO) depends tremendously on when a person purchased the shares. However, with the shares on a decent run for the last few years, and currently trading at nearly 20 times forward earnings, it might be time to step back and reevaluate the company's prospects.

The Bear Case:

A recent article was titled "Is It Finally Time to Sell Coca-Cola?" The premise of this article was that investors have to be careful not to assume that a stock's price increase will continue forever. The author specifically cited Microsoft and Cisco Systems, as companies that had good runs, but their stocks peaked and investors booked profits. The author gave several reasons for investors to possibly expect challenges with Coca-Cola going forward. First, the company has seen an increase in short interest. From August through September, the number of shares sold short has jumped from about 23 million to over 53 million shares. In addition, the company is likely to see lower sales growth over the next few years versus the prior five. Analysts generally expect revenue growth of between 4% and 5%, versus the 10% growth the company has managed over the last several years. Another issue that Coca-Cola faces is, that the company's sugary drinks could be targeted as a health concern.

The Bull Case:

The Motley Fool's own Andrew Marder recently penned an article titled, "Why Investors Should Continue to Love Coke." Andrew made several points, beginning with the fact that the company has, "the stickiest brand moat in the world." He specifically pointed out that Coca-Cola's branding is known the world over, and the size of the company's sales dwarf their smaller competitors. In particular, when you compare beverage sales at Coca-Cola and PepsiCo (NYSE: PEP), we find that both of these giants had roughly $11 billion in sales in the same timeframe that Dr Pepper Snapple (NYSE: DPS) sold $1.6 billion. In addition, Andrew cited Warren Buffett's 9% Coca-Cola stockholding as the, "wisdom of really smart people" as another reason to buy the stock.

Is Coca-Cola The Best Beverage Buy?

For many people, the beverage industry offers attractive investments, as it's relatively recession resistant, and most of the companies pay decent dividend yields. If investors are choosing between the two largest companies, the choice seems relatively easy at the current time. Coca-Cola beats Pepsi in nearly every measure. The company's growth rate is higher, revenue growth is expected to be higher, and Coca-Cola's gross margin is nearly 8% better.

If we compare Coca-Cola to Dr Pepper Snapple, the number comparison isn't quite as easy, but Coca-Cola's product lineup is much better. While analysts are calling for Dr. Pepper to increase earnings at a slightly higher rate than Coca-Cola, and the company pays a better yield as well. The issue I have with Dr Pepper Snapple is their product lineup is missing some of the best growth markets in the industry. If one concern about growth in the future is tied to the sugar content of popular soft drinks, then Dr Pepper Snapple will face a big challenge overcoming this obstacle. The company's focus has been on improving their soft drink performance at the expense of developing non-soft drink brands. In the last few quarters, the fastest-growing segments in the beverage industry have been water, tea, and energy drinks. Dr Pepper Snapple only has a significant presence in tea and offers virtually nothing in the bottled water or energy drink segment.

In our final comparison, Monster Beverage (NASDAQ: MNST) is a fast-growing, but very small competitor to these other behemoths. While Monster is expected to grow at about double the rate of their beverage competitors, the company has the lowest gross margin of the four. If unhealthy ingredients are going to be attacked, Monster would suffer the most. An additional challenge for investors in Monster is, the company's P/E ratio is almost double most of their competition. If we assume that Coca-Cola is the best beverage investment, which appears to be the case, then the only question left is, should you buy the stock today?

The Existing Investor vs. The New Investor:

Determining the fair value of Coca-Cola for an investor buying today is a totally different exercise than an investor who already owns the shares. An existing investor must first consider when they purchased the shares, and determine their effective yield. This is why for an investor like Warren Buffett who purchased shares years ago, the question of whether Coca-Cola is a good investment is almost a nonstarter. The reason for this is, Warren Buffett's effective yield is likely many times higher than an investor buying the shares today. This means he can afford for the stock to drop some, even if it's considered overvalued, because his dividend yield will still generate significant income.

If investors are considering the stock at current prices however, the exercise is a bit different. By multiple measures Coca-Cola could be considered overvalued, it appears neither revenue or EPS growth in the future will match the last several years. In the prior five years, sales growth has been nearly 11%, while EPS growth has been 12.5%. Analysts expect revenue growth next year at just 5.1%, and longer-term earnings growth of just over 7%. With both revenue and earnings growth coming in much lower than the prior five years, one would logically expect the company's P/E ratio should compress as well. However, the stock sells at a forward P/E ratio of over 19 versus an average of about 18 and the last five years. Unless Coca-Cola makes some type of transformative acquisition to give the company better growth in the future, it's possible investors buying at these levels will be disappointed. Keep in mind, this is not to say that Coca-Cola is a bad investment for everyone, but rather that at current prices the stock likely needs to take a rest to become a better value.

MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of The Coca-Cola Company and PepsiCo. Motley Fool newsletter services recommend Monster Beverage, PepsiCo, and The Coca-Cola Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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