Is The Coca-Cola Company (KO) Finally Cheap Enough to Buy?

Meanwhile, Dr. Pepper Snapple is too small to pose a real threat to The Coca-Cola Company (NYSE:KO) and there are no similar companies that it could combine with to stage a legitimate challenge. Dr. Pepper Snapple lacks the distribution network and brand equity that enables Coca-Cola to sell its products profitably in over 200 countries. As a result, Dr. Pepper Snapple will have to be satisfied with its strong shares of niche markets — like sparkling drinks — and its third-best carbonated soft drink market share.

Free cash flow indicates likely investor return

Coca-Cola’s market position enables it to earn stable and predictable cash flows year after year; this makes valuation a relatively simple task.

The company produces $1.72 per share in free cash flow during 2012. $1.72 divided by its recent market price of $40.49 per share gives an initial free cash flow yield of 4.2%. Think of this like a bond that will pay an annual coupon of $1.72 per share.

However, Coca-Cola’s stock is not a typical bond — it is a bond with growing coupons. The company earned $1.72 per share in free cash flow during 2012, but it earned only $0.94 per share in 2003. The compound annual growth rate from 2003 to 2012 is nearly 7%.

The Coca-Cola Company (NYSE:KO) is like a bond selling at par that pays a 4.2% coupon — and that coupon has grown at an annual rate of 7% over the last decade. However, it will be difficult to maintain the same growth rate in the future, so perhaps a forward estimate of 5% annualized growth going forward will be more accurate.

If you combine the current 4.2% yield with a 5% annual growth rate in free cash flow per share, you get an estimated annual return of 9.2%. This should be much better than the market returns over the next few years, but it is not a screaming cheap stock since you have to pay up for growth.

Coca-Cola is a cheap stock today, but it will not be screaming cheap until that initial yield is closer to 10%.

The article Is Coca-Cola Finally Cheap Enough to Buy? originally appeared on Fool.com and is written by Ted Cooper.

Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and PepsiCo. The Motley Fool owns shares of PepsiCo. Ted is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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