DJIA Analysis - The Coca-Cola Company
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Finding the Intrinsic Value of the Market
In this investing series, I seek to find the intrinsic value of the Dow Jones Industrial Average through a brief fundamental analysis of each of the 30 companies included in the average, with the goal of deriving an intrinsic value for the market as a whole through a ‘sum of the parts’ analysis. I will also attempt to make recommendations on how to play each company on the DJIA for optimal investing performance.
In this article, I will attempt to analyze The Coca-Cola Company’s market prospects for 2012 and beyond with a brief fundamental analysis:
The Coca-Cola Company (NYSE: KO) is a classic American company with a business that I appreciate everyday. The world’s largest nonalcoholic beverage company, it sells more than 500 varieties of beverages throughout the world. Along with owning Coca-Cola, the world’s most valuable brand and a drink that I had with dinner last night, the company sells brands such as Diet Coke, Fanta, and Sprite. Other names you may recognize are: Thums Up (extremely popular in India), Minute Maid, Hi-C, Nestea Teas, Dasani, and Powerade. These brands are sold in virtually every market throughout the world, and the company continues to penetrate new markets for growth in the form of new brands or marketing methods.
The Coca-Cola Company is an extremely profitable company, having maintained average returns on equity above 35% for most of its lifetime. Coke has an easily identifiable consumer monopoly, or economic moat, in its brand recognition. As a result, Coke has won the Buffett Premium, making it well known as a high quality company.
While Coke has extremely high quality of management, it does compete with PepsiCo, Inc (NYSE: PEP) in its main drink brands. The battle between Coke and Pepsi has been an international all consuming fight for which there may never truly be a victor. However, I prefer Coke and so I know I would take the Coca-Cola Company over PepsiCo any day(EDIT: As mentioned in a comment, this sounds a bit ridiculous. I intended to say I would take Coca Cola Company over PepsiCo in this brand battle, I apologize if it seemed that I was judging the two companies as that was not the intent of this article or the previous statement).
After correcting for a quarterly abstraction in quarterly earnings, Coke has historically achieved a 11% compounded annual growth in net income. As the market environment dulls, I see Coke’s economic moat allowing it to continue its growth into the future even in tougher markets. This company is a dividend aristocrat, paying out consistent and increasing dividends for each of the last 25 years, and currently pays a 2.75% dividend yield. At a normalized price of about 15x earnings, KO is relatively cheap for the brand that an investor pays for.
Using the Discounted Free Cash Flow model, I used a discount rate of 12% after my WACC calculations yielded a discount rate of 9.79%. Knowing the strength of Coca Cola’s economic moat, and having calculated that Coca-Cola’s 4 year compounded annual FCF growth rate is 8%, I assumed that for the next 10 years, The Coca-Cola Company could grow FCF by at least 7% annually. After that, I assumed that the strength of KO’s business would allow it to grow FCF by 2% perpetually. This gave The Coca-Cola Company an intrinsic value of $84.83.
The intrinsic value calculation for KO makes it currently undervalued by around 20%. However, due to the consistency of KO’s business, I do not expect any major out of the ordinary catalysts to take place to allow for a special category of investment in KO. I believe that the optimal investment in KO would also be the simplest: Buy KO common stock at today’s market prices and expect a solid return on this dividend aristocrat.
Tracking The Series:
1. 3M: +.6% (including covered call premium).
2. Alcoa: -3.8%
3. Wal-Mart: +5.8% (including covered call and naked put premiums).
Fool Blogger Nikhil Shamapant does not own any shares in the companies mentioned above and will not buy shares in the next two trading days.