Coca-Cola stock (NYSE:KO) has risen 15% this year, surpassing the S&P 500, which has increased by 2%. This remarkable rally prompts a vital question for investors: Is KO stock currently overpriced, and is it possible that it could face a significant correction, perhaps by 25-30% or even 50% to below $40?
Well, here’s the concern – at around $70 per share, KO stock seems costly. It is trading at 29 times its earnings from the past twelve months. To illustrate, this results in an earnings yield of merely 3.4%. For context, Google, which leads the search market with an average revenue growth of 10% in recent years, trades at a lower multiple of 19 times earnings. Coca-Cola’s average revenue growth of just about 2% over the last three years is insufficient to justify such a high multiple. The price you pay is significant. We have developed the Trefis High-Quality Portfolio with a focus on relative valuation. Notably, HQ has achieved a return of over 91% since its inception, outperforming the S&P, Nasdaq, and Dow — all of them. Separately, take a look at – Should You Buy CRWV Stock After A Whopping 4x Rise?
Why Is Coca-Cola So Expensive?
The current valuation of Coca-Cola is influenced by strong organic sales growth, which saw a 6% year-over-year increase in the last quarter. This growth stems from several key factors: increasing sales volumes, effective pricing strategies, and successful revenue growth management. Additionally, the company’s initiatives to enhance cold drink equipment deployment and optimize its brand portfolio towards higher-margin products are further propelling its growth.
In addition to top-line growth, Coca-Cola has also achieved margin expansion. Its operating margin has notably risen from 28% in 2022 to a respectable 30% in the last twelve months, indicating improved operational efficiency and profitability.
What’s Next for Coca-Cola?
While Coca-Cola’s organic revenue growth is expected to stay within the mid-single digits, its margin expansion is not anticipated to continue at the same rate. This implies that Coca-Cola’s valuation should be more aligned with other companies experiencing 5-10% revenue growth.
For example, consider Block Inc., which trades at about 15 times earnings and enjoys a 13% average annual growth rate. Compared to this, Coca-Cola’s current valuation appears inflated. If Coca-Cola were valued at Block’s multiple of 15 times earnings, its stock price would hover around $40 per share. This raises an essential question for investors: does Coca-Cola’s growth profile even justify a lower multiple than that?
Why Coca-Cola Might Still Be a Reasonable Investment
Despite worries about market saturation, Coca-Cola’s performance is closely tied to global economic growth, increasing disposable incomes, and population growth, particularly in emerging markets.
A robust economy, supported by stabilizing inflation and renewed consumer confidence, could significantly enhance discretionary spending and out-of-home consumption. This uptick in economic activity directly results in higher demand across all channels. Notably, increased per-capita consumption in developing markets also propels demand for the company’s high-margin concentrate business, which is its most profitable segment.
Moreover, under volatile market conditions, Coca-Cola frequently acts as a “safe haven” investment. During periods of uncertainty, such as looming trade tariffs and geopolitical tensions, investors often gravitate towards stable, established companies with predictable earnings. This heightened demand for safety can lead to increased valuations, even for firms with more modest growth expectations.
Understanding Risk-Reward Through Comparison
Comparing Coca-Cola with companies like Google and Block is not about finding direct substitutes, but rather about comprehending the relative appeal and risk-reward dynamics of an investment. When evaluating KO, investors ought to contrast its potential returns against alternatives like holding cash (earning interest) or investing in a broad market ETF like the S&P 500.
Utilizing “anchor” assets like Google and Block, which trade at comparatively low multiples, offers a vital perspective on the risk-reward profile of KO. These comparisons assist investors in determining whether the anticipated return on KO stock justifies the associated downside risk, especially since these anchor stocks present more compelling growth stories. This analytical method is essential for making informed investment choices.
Regardless of the trade-off, investing in a single stock can be risky. On the flip side, the Trefis High Quality (HQ) Portfolio, comprising 30 stocks, has shown a track record of comfortably outperforming the S&P 500 over the past four years. What accounts for this? Collectively, HQ Portfolio stocks have delivered superior returns with reduced risk in comparison to the standard index, with a more stable performance evident in HQ Portfolio performance metrics.
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