Coca-Cola (NYSE: KO) has a lot going for it by all appearances. It has benefited not only from creating one of the world’s most recognized brands — its eponymous soda — but now offers a host of other drinks as well, such as Dasani, Powerade, and Gold Peak, in more than 200 countries.
It also maintains one of the longest dividend growth streaks in the stock market, and Warren Buffett’s Berkshire Hathaway has owned a massive stake in the company for decades. Given such accolades, one can see why it is a moderate buy on a consensus basis, according to TipRanks.
But despite such accolades, Coca-Cola faces significant challenges. While nobody should expect the company’s demise, its challenges may leave investors questioning why they would want to own this stock today.
Admittedly, Coca-Cola’s challenges are unlikely to destroy the company. Its numerous brands and its success in developing and buying popular brands should help it maintain a stable and gradually increasing revenue base.
Such accolades likely helped attract interest from Warren Buffett in the ’80s and ’90s as he built and increased his stake in the company. Consequently, Buffett’s Berkshire Hathaway owns 400 million shares of the beverage giant, which amounts to just over 9% of the 4.32 billion outstanding shares.
Berkshire has also profited handsomely from the company’s dividend, which Coca-Cola has increased 61 years in a row, giving it Dividend King status. The payout now stands at $1.84 per share annually, and this results in a dividend yield of 3.2%, about double the S&P 500 average of 1.6%.
Coca-Cola’s payout alone has handsomely rewarded Berkshire. This year it will receive $736 million in dividend payments, a 57% annual yield on the original $1.3 billion investment. That cash return is likely why Berkshire continues to hold this stock.
Despite the dividend, one would be right to question why Berkshire still owns this stock. For all of the focus on Berkshire’s Coca-Cola position, investors may forget that Buffett’s company has not bought any Coca-Cola shares since 1994.
Also, even with a current price-to-earnings ratio of 23, the stock has sold at a higher valuation in recent history. With Buffett’s inclination to seek bargains, one might understand the lack of buying activity.
Moreover, even when including dividend income, Coca-Cola has dramatically underperformed the S&P 500 over the last 10 years. Unfortunately, the dividend could even be an obstacle to its improvement.
KO Total Return Level data by YCharts
For 2023, Coca-Cola expects around $9.5 billion in free cash flow. However, the company is on track to spend nearly $8.2 billion in dividend expenses for the year. This presumably leaves Coca-Cola with only about $1.3 billion to spend on share repurchases and reinvestments into the company, a factor that could limit long-term growth potential.
Additionally, after 61 straight years of payout hikes, abandoning such a streak could severely undermine confidence in the stock. Hence, investors should expect the company to maintain that streak, even at the expense of long-term growth.
Investors are likely better off avoiding Coca-Cola stock now. Indeed, Coca-Cola and its brands are not going anywhere, and it should remain a stable source of revenue and free cash flow for its shareholders. These reasons are likely why the analyst consensus considers Coca-Cola a moderate buy.
However, the problem is its underperformance in recent years. The considerable dividend expense and the increasingly burdensome pressure to raise it yearly crowd out needed investments in the company. Due to those pressures, even conservative, income-oriented investors would likely earn higher returns elsewhere.
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Will Healy has positions in Berkshire Hathaway. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool recommends the following options: long January 2024 $47.50 calls on Coca-Cola. The Motley Fool has a disclosure policy.
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