To no surprise, Coca-cola (KO) showed up on my watchlist this week of companies with excellent long-term returns on equity. KO is widely regarded as one of the finest businesses in the world. Even after well over a hundred years of growth, the company is still expanding and has huge untapped and under-tapped markets ahead if it. Its moat is wide, and it has shown a great ability to not only grow its core brands, but also to adapt to local tastes and develop or acquire new products.
The stock has performed well as of late and is currently very close to its 52-week high.
Today, I am taking a look at KO’s valuation. I am using the general approach put forth in Prem Jain’s excellent book on Warren Buffett called Buffett Beyond Value: Why Warren Buffett Looks to Growth and Management When Investing.
Based on KO’s long-term track record, I am estimating that EPS will grow at a rate of 8% annually over the next decade. The mean EPS estimate for 2010 is $3.50. Assuming 8% annual growth, EPS will be $7.54 in 2020. I am further assuming that given KO’s superior economics it deserves a P/E of 20, if fully valued. Its median P/E over the past decade has been 21. That would give KO a price of $150.80 in 2020. Using a discount rate of 7%, the present value of KO’s stock is $76.67.
Now let’s look at KO’s dividends. I estimate that KO will pay a dividend of $1.84 over the next 12 months and that the dividend will also grow at a rate of 8% over the next decade. By my estimate, KO’s dividend has grown by over 10% annually over the past decade. Using the same discount rate of 7%, the NPV of KO’s dividends over the next decade is $17.94.
Add the NPV of the dividends ($17.94) and the present value of the 2020 stock price ($76.67) and you get an intrinsic value of $94.61, which is a discount of about 35% from where it is currently trading. The discount coupled with KO’s formidable moat gives you a margin of safety.
By comparison, using a discount rate of 12% in the same equations gives an intrinsic value of about $62 per share. KO traded as low as $50 per share within the prior 52 weeks. Director Barry Diller purchased $20 million of the stock at $39.91 in March of 2009. Diller recently raised his stake by purchasing another 120,000 shares at a cost of $7.4 million.
Of course, when doing this type of analysis it makes sense to plug in your own assumptions for the growth rate, discount rate and terminal P/E.
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