Once leaving internships and entering the real world of professional finance, one thing many analysts quickly realize is the appeal of boring. Asset managers, for instance, will often recommend boring stocks as long-term holds with a conservative strategy to avoid drawdowns and exposure to market crashes. While sexy headlines are easy with huge gains at companies like Advanced Micro Devices (AMD), those gains come after steep declines, and it takes a savvy and lucky investor to know when to jump in—and an intelligent professional to know how to diversify against risky exposure to stocks like these.
For this reason, many analysts will spend a lot of their time doing simple DCF of stocks like Coca-Cola (KO), looking at how these companies can continue their stupendous track record of capital gains and dividend growth. KO’s dividend has more than doubled in the last decade, and its stock has almost doubled as well. That includes the 2008-2009 debacle, which is interesting in itself, because KO fell 34% from peak to trough—far less than many mid-cap stocks and the S&P 500 as a whole.
So buying and holding a stock like KO is sound financial advice in many situations, but is it now? With a P/E ratio of 25, which exceeds the market as a whole, and revenues declining year-over-year for the last 5 quarters (and several quarters before that), it might make sense to reconsider the age-old wisdom of buying and holding a dividend champion like this.
That’s where deep financial analysis is necessary.
Going through KO’s 10-Qs gives us an interesting insight into the structure of this cash generating machine. With a profit margin over 25% last quarter and well in the teens for several quarters before that, it is clearly not a stock to short. But other metrics are worth considering. KO’s common shares outstanding remain virtually flat over the last two years, but back in 2012 the company was aggressively planning to buy $19 billion in shares. With that no longer the case, one has to wonder how much of the company’s cash is being returned to shareholders.
Another issue: the dividend and EPS. Taking the dividend first, we got an increase at the beginning of 2016 like we do every year—an increase of 6%. That is less than the 6.4% increase in 2015 and the 10% increase in 2014. This decelerating divided growth demonstrates the company is handing over less cash to shareholders than it used to.
Is this because there’s less earnings to give? Total EPS was $1.67 in 2015, an 11% decline from the prior year. And that’s after 2014 saw a 4.5% decline in EPS from the prior year.
Does this mean it’s no longer worth recommending this boring stock to clients? Not exactly. There’s much more to look at, such as FCF, changes in the operating margin (which surged last quarter), and cash from operating activities. Also it would be important to look at the company’s debt load and the reason behind its changing debt to equity ratio.
Suddenly, KO is not so boring. In fact, it is a complicated multinational firm with billions of dollars to dole out to investors, and it may fit the profile of your client. It may not. But you won’t know until you dig into the SEC filings and find the story behind the income statement and balance sheet.