Coca Cola Stocks
Enjoying Coca Cola – Should you buy Coca cola stocks

Coca-Cola has found itself struggling in some very choppy, some might even say, tumultuous waters. Over the past decade, the beverage world has been unceremoniously flipped,head over heels, in the surf. The latest report by New York Times determined that there is clear evidence that consumers are losing their taste for soda. And it doesn’t matter the brand—Dr. Pepper, Pepsi, even the almightyCoca-Cola—all are falling out of favor.

Intuitively, you might presume that Coca-Cola shares are responding to the impending demise of soft drinks with a nosedive. But what’s happening is, in fact, a paradox; Coca-Cola shares are, instead, surging!

What exactly are investors factoring into the equation?  And is this factor a “good enough” reason to buy Coca-Cola shares for the long haul?

New Business Model Lures Investors

Carbonated beverages like Coke (of course), Diet Coke, Coke Zero and Sprite are Coca-Cola’s main source of revenues. The changing consumer taste in favor of other types of beverages is the biggest risk to Coca-Cola’s future.

Given that risk, Coca-Cola had little choice but to diversify its business. Coca Cola has pursued an aggressive tactic of mergers and acquisition. The company has very selectively acquired smaller beverage makers to bring into the fold. They choose only those which have growth momentum so they can be easily absorbed into Coca-Cola’s massive brand. Some of the more noticeable examples include the acquisition of juice maker Jugos del Valle for $470 Million and the acquisition of a 16.7% stake in Monster Beverage for $2.15Bln.

Coca-Cola’s portfolio of brands now includes natural juices (Minute Maid, Simply Juice, Fuze), energy drinks (Monster, Full Throttle and NOS) and flavored teas (Honest Tea and Gold Peak). Coca Cola’s mergers and acquisitionsefforts have, in fact, been so aggressive that under Coca-Cola’s umbrella there are currently 20 billion dollarsbrands.

Yet Coca-Cola’s strategy goes beyond diversity. The fact is a more diversified portfolio ofbrands paves the way for higher growth which could ultimately leadto higher earnings. And when investors expect a company to post higher earnings their natural instincts are to buy shares.

But Wait! There’s a Caveat

The seemingly limitless number of brands now under the Coca-Cola umbrella may create the notion that the transitions have all gone smoothly. But this is not exactly the case; there are still numerous challenges to face.

Coca-Cola is, in fact, at a critical phase in its transition. On the one hand,24% of its revenues are still coming from the sparkling category. That means that the company is still quite vulnerable. On the other hand, Coca-Cola has to continue to fund its acquisitions and execute its mergers and acquisitionsstrategy. In other words, Coca-Cola has no choice but to spend money at the same time that its revenues are stagnating.

Coca-Cola has been proactive so that it can maintain existing profitability levels and continue its acquisition strategy. It has been slashing operational costs as well as headcounts. It is also currently in the midst of an extensive reorganization of its distribution mechanisms and bottling plants.

Investors Shrug Off Risk

Investors clearly have made up their minds and decided to shrug off short term risk. Sentiment for Coca-Cola stock has been strikingly bullish. Perhaps even surprisingly bullish, despite a rather mixed 2015 earnings report which included a 4% fall in revenues on a Year on Year basis to $ 44.3Bln, and  earnings per share rising by 4% Year on Year.

The fact is investors’ sentiment is being driven by headlines rather than actual financial results. Every time news comes of another beverage maker being acquired by Coca-Cola, Coca-Cola shares gain. Of course, that means pushing the share price to trade at a high premium.

Perhaps the best way to illustrate exactly how much of a premium investors are pushing is by using the conventional valuation methodology of Price to Earnings. Using the Price to Earnings valuation, dividing Coca-Cola’s earnings per share to its share price, the conclusion becomes clearer still. The Price to Earnings valuation suggests Coca-Cola shares (at their current price) are trading at 27 times earnings. The rule of thumb is that any Price to Earnings ratio above 20 is an indication that the stock is expensive. Clearly, the premium on Coca-Cola shares suggests investors are already pricing in expectations of higher earnings. The chart below illustrates the rising Price to Earnings ratio by comparing earnings to the share price.

Are Coca-Cola Shares Worth Holding?

(Source: Morningstar)
(Source: Morningstar)

Let’s take a step back and weigh in. Coca-Cola’s business plan is expected to bear fruit in the future and reduce the company’s risk that stunted its growth. But on the flip side, investors that buy and sell Coca-Cola shares on the back of news have been enthusiastically optimistic. And that, of course, resulted in Coca-Cola shares trading at a high premium.

Under such circumstances, are Coca-Cola shares worth it? If you favor risk,then perhaps. But when so much good news is factored in (and so little of the company’s actual performance is not) it leaves little margin of error. And therefor, the blunt and simple answer must beno! Coca-Cola shares are just too risky.

 

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