Since 2012, Coca-Cola (KO) stock has traded in the low $40 range. It has hit the upper $30s higher and there, but over 82% of the trading days since the start of 2012 have found the stock essentially treading water in the range of $40 to $45 per share. This lack of capital appreciation has triggered a spate of people wondering whether the welcome trend towards fighting obesity has hampered the growth prospects of Coca-Cola’s flagship products and whether a company selling $42 billion worth of beverages each year is capable of posting respectable growth figures.
Over the past four years, the S&P 500 has delivered returns of almost 14% per year. It sounds crazy, but the collection of business that comprise the S&P 500 has almost doubled your wealth in the past four years as it has turned every $1 invested in January 2012 into $1.85 today. I call it “crazy” because it comes directly on the heels of a three-year bull run in which the stock market delivered 22% annual returns from March of 2009 through the end of 2011. Cumulatively, the S&P 500 has returned 17.3% since its March 2009 and turned every $1 into $3.34 today.
You might look at Coca-Cola’s stock price stagnation since the start of 2012 and wonder: What the heck is going on? What’s this all about?
There are four things you ought to keep in mind here:
First, the amount of cash payments that Coca-Cola shareholders have received as dividends over the past four years is not insignificant. They got to collect $1.02 in 2012, $1.12 in 2013, $1.22 in 2014, $1.32 in 2015, and $1.40 per share in 2016 (the last $0.35 of that hasn’t been paid out yet.) That is $6.08 in dividend income per Coca-Cola share over four years, or 14.4% of its current valuation.
Better yet, for people who reinvest, the actual amount of income collected per share is $7.13 that has gotten reinvested at an average price of $40.81 per share. That means if you have done nothing but passively reinvest for the past four years, each share has gone to produce 0.174 additional shares of Coca-Cola. Someone that bought 100 shares of KO stock in January 2012 is now sitting on 117.4 shares.
That’s $730 in current economic value that got created out of a $4,000 initial investment for a 4.28% annual compounding rate just from dividend reinvesting alone. The share price may not have gone anywhere, but the share count has increased by 17%.
And secondly, a period of high single digit earnings growth following a period of stagnation is not the worst thing for compounding because you get to rack up additional shares at a low price (it’s also not the best thing, as the stagnation likely means that your rate of dividend growth is down as well.) This is why I have profiled those Johnson & Johnson case studies from when the stock was stuck trading in the $60s due to manufacturing recalls and slow revenue growth. You come back a few years later with Johnson & Johnson in the $100+ range, and suddenly, those shares that got created in the $60 range convert into a 67% capital gain. I analogized it to a coiled spring that is loaded and ready to enhance future compounding. When Coca-Cola trades at $60 per share in a few years, you will not only get those 100 shares trading at $60 but also those 17 shares created at $40 plus all the additional shares that the interim dividends fund.
Third, people are discounting the fact that Coca-Cola is a heavily international operation and over-weighing the effects of stagnant revenue growth. People are fretting that Coca-Cola’s earnings have only increased from $1.92 to $2.00 per share over the past four years when a constant-currency analysis would suggest growth from $1.92 to $2.30 per share. That’s 4.62% annual earnings growth that really happened rather than the 1.03% that some people think.
This means the problems are much more solvable than people think. Getting 4% growth up to 6-7% isn’t unlikely, and coupled with a 3% dividend, you’re looking at 9-11% annual returns depending on whether you reinvest along the way. Considering you’re getting a business that increases its payout to shareholders each year, that is a heck of a risk-adjusted deal. Working with a “disappointing” 4% growth base is a lot easier than a 1% one.
And fourth, Coca-Cola’s balance sheet has been improving. When it purchased and integrated its bottling operations between 2009 and 2010, its debt shot up to $42 billion while its cash position dwindled to the $10 billion range. Now, Coca-Cola is sitting on $22 billion in cash against $46 billion in debt. It will be able to do things like purchase $4 billion in bottling operations from SABMiller in Africa as it integrates with Inbev so that the beer colossus won’t have a foot in the door for a takeover.
I mention all of this to suggest that the underperformance at Coca-Cola likely won’t last. You don’t want to go through life holding during the underperforming times and leaving just before the good times arrive (and though that sounds obvious, a lot of our natural emotional wiring can lead us to do just that.) Coca-Cola’s dividend is adding a nice mid single digit gain to the total return, and this might look even better in hindsight once there is some growth to support capital appreciation. And the earnings growth these last few years aren’t as bad it appears due to the strength of the American dollar. And the cash position is piling up. Now is not the time to discard this historically excellent compounder. The downside hasn’t been that bad, and better compounding days lay ahead.